We’re in the deepest recession ever. So why is the stock market rising?

2020 has been an unprecedented year for the global economy. The coronavirus pandemic has affected almost every corner of the world, pushing many countries into the deepest recession since the 1920s and 1930s.

The Office for National Statistics reported that the UK economy shrank by 19.8% in the second quarter of 2020, officially pushing the country into a recession after a decline of 2.5% in the first three months of the year.

In the US, gross domestic product (GDP) from April to June declined by a staggering 31.7% on an annualised basis. Germany’s GDP fell 11.7% year-on-year, France by 13.8%, and Italy by 12.8%.

However, even though the world is experiencing its worst economic contraction since the Great Depression, most global stock markets are recording growth. The Dow Jones Industrial Average and S&P 500 have risen by more than 50% since hitting the bottom in March. The FTSE has also gained more than 1,000 points from its March low.

Here’s how the main regional indices have performed in the last quarter, and year to date. Apart from the UK FTSE All-Share, all other indices rose between July and September.

Source: JP Morgan

So, if economies are as bad as they seem to be, why on earth is the stock market rising? Here are three reasons.

1. Stock markets look to the future

When looking at stock market performance, it’s worth remembering what stock markets care about. Markets are generally forward-looking, and prices are typically affected by whether things are getting ‘worse’ or ‘better’.

Current share prices partly reflect optimism about the imminent arrival of an effective Covid-19 vaccine, robust ‘test and trace’ procedures, and radically improved treatment options. These factors enable more targeted and limited lockdowns, meaning that economies are unlikely to close in the same way they did in early to mid-2020.

Even though many corporations might not be as profitable in 2020, news about medical breakthroughs suggest that things are getting ‘better’. This represents a positive development for the economy and for corporate profits, driving up share prices and markets.

2. Many large corporations are multinational

It’s also worth remembering here that the stock market is not a snapshot of the wider economy. The FTSE 100 or S&P 500 are made up of big corporations, and these companies operate under very different circumstances than the average small business.

Typically, these huge corporations:

  • Are highly profitable
  • Hold significant sums of cash
  • Have regular access to public bond markets.

In addition, they are generally far more multinational than the typical family business, meaning a local lockdown won’t impact their profitability in the same way. For example:

This brings us on to…

3. Bigger companies are better placed in a world of social distancing

As we have seen from the huge profits generated by Amazon, Facebook and Google in 2020, the current economic pain is not being felt by large, publicly traded companies.

Instead, the damage is being done to small, local businesses such as cafés, dry cleaners, and concert venues – none of which are listed on the stock market.

As esteemed professor of economics and public policy at Harvard University, Kenneth Rogoff, says: “These smaller players simply do not have the capital needed to survive a shock of this duration and magnitude. And government programmes that have helped to keep them afloat for a while are beginning to lapse, raising the risk of a snowball effect in the event of a second wave.”

Finally, large national or multinational companies also tend to be technologically capable, meaning they are well-positioned to compete in a world where social distancing has hit bricks and mortar firms. Local businesses, in contrast, are more likely to be on the high street and therefore hampered by restrictions on movement.

Of course, as many small and previously viable businesses fail, this is even better news for the larger corporations as it leaves them in an even stronger market position when the virus abates. This has the effect of pushing their share price up yet further.

What goes up can also come down

For these reasons and more, stock markets are mostly performing well, despite wider economic uncertainty. However, there may be storm clouds on the horizon.

In the US, the upcoming presidential election represents a major risk. A close result could lead to a constitutional crisis, and a Biden win could result in policies designed to curb the ‘monopolistic’ practices of some of the US tech giants.

And, in every election year since 1945 when the incumbent loses, the market is, on average, negative for that quarter.

In the UK, the continuing drift towards a no-deal Brexit is also generating significant uncertainty. Until such a time as a free trade agreement is negotiated, or transition arrangements extended, businesses are holding their breath to see on what terms they will be able to trade with the UK’s biggest partner.

As Rogoff concludes: “Until lofty stock market valuations are underpinned by a broad-based recovery in both health and economic outcomes, investors should not get too comfortable with their outsize pandemic profits. What goes up can also come down.”

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