Success of the Stock Market Despite Covid-19
While millions of Americans are struggling financially due to COVID-19 lockdowns and unemployment, a seemingly strange economic phenomenon is occurring: stocks and market indices are hitting record high valuations. To provide some context, stock markets have been generally seen as an indicator of economic activity. Therefore it is surely unexpected that stock prices are rising quickly while the world is going through one of the largest global recessions in history. The S&P 500 Index, one of the most commonly followed equity indexes, is currently trading at a record high of over 3,700 points (editorial note: at time of writing). With our economy so fragile, how can prices continue to rise?
One consideration stands out above the rest concerning the lockdown’s economic impact. As politicians were quick to temporarily close businesses, an inequality was immediately created: The lockdowns mainly affected small businesses, an important aspect of the American economy, but not a large player when it comes to equity markets. Furthermore, with small local businesses closed, consumers turned to large companies to supply everyday essentials including grocery items, toiletries, and electronics. Not only did such companies underrepresented in the stock market take the hit when the pandemic struck, but large corporations quickly capitalized and met the needs of the consumer by offering new services such as free shipping or curbside delivery options, boosting their revenue and ultimately their share prices. Additionally, the S&P 500 and similar indices are weighted to favor larger companies. When it comes to their rising market prices, not only are the largest companies in America not feeling the economic impact that small businesses have felt, but they are overrepresented in any capitalization-weighted index.
Another factor considered is the overall nature of the market. Stock market prices tend to look towards the future, reflecting optimism and future growth rather than only the current state of the country's economy. While economic activity has slowed, traders are hopeful regarding the availability of an FDA approved COVID-19 vaccine. As of now, drug manufacturers Pffizer and Moderna have successfully introduced their own vaccinations. US Secretary of Health and Human Services, Alex Azar, predicts that by early March 2021, vaccinations will be available at pharmacies across the country. As the vaccine serves as an indicator towards the end of the pandemic, markets are currently reflecting an optimism for economic growth. Unlike previous depressions and recessions, the current economic downturn is directly related to the pandemic, a factor which will easily be mitigated in the coming months. Investors are hopeful that with the vaccine, economic activity will resume to pre-pandemic levels.
While many monetarist-minded economists and libertarians decreed the economic response by the US government as detrimental to the future of the US economy, two key actions taken by the government surely had an impact on the current economic state of the country, including our financial markets. First, as part of government efforts to mitigate the recession, the Federal Reserve slashed interest rates to near zero. With anticipation that current rates will remain, the low financing costs allow for increased borrowing and investing, driving up real estate prices and commodities. The Reserve also practiced quantitative easing, a form of injecting money into the economy by buying long term government bonds. Second, the federal government instituted several policies to pump trillions of dollars into the American economy, into the hands of citizens and businesses. The CARES Act, passed by Congress and signed by President Trump, included the “Paycheck Protection Program” to supply relief loans to businesses who keep their staff on payroll, sent direct cash checks to certain eligible citizens, and increased welfare checks for individuals receiving unemployment benefits. These relief programs kept businesses and individuals afloat, preventing layoffs and replacing income.
With unprecedented government spending, the federal deficit for fiscal year 2019-2020 reached a record 3.1 trillion dollars. (For context, the 2018-2019 year deficit was kept under a trillion dollars.) With the 2020-2021 fiscal year’s deficit already reaching 400 billion dollars, economists predict mass inflation in the coming years. This may be an additional incentive to place money into financial markets in order mitigate inflationary effects and the devaluation of capital.
While the success of current markets are understood, one question stands: what long term effects will the pandemic and the US government’s economic response have on the stock market? It is certainly feasible that markets will enter a bear market quite soon. Not only may a stock bubble be forming, but government debt can expand to unmanageable levels, prompting the Fed to print money and inflate US dollar in response.