The latest job report showing record unemployment in the United States highlights a growing divide that investors are struggling to reconcile: a booming stock market and a struggling economy.
Gains in US stocks accelerated on Friday after April’s non-farm payroll report showed unemployment had reached 14.7%, the highest level ever. It is the latest development to scratch the heads of many market observers, who analyze a constant flow of catastrophic economic data while observing the recovery of the American stock market.
Within weeks, a decade of job gains was wiped out. Meanwhile, consumer spending fell as businesses were closed across the country and manufacturing activity contracted at the fastest rate since the last recession.
The disconnect between the economy and the stock market has increased this week. The Nasdaq composite index, rich in technology, entered positive territory for the year, erasing a large part of its losses from the rout fed by coronaviruses. Other major US indices also posted solid gains for the week. The S&P 500 rose 3.5%, while the Dow Jones Industrial Average rose 608 points, or 2.6%. The Nasdaq Composite added 6% for the week.
All three indexes rose more than 30% from their March 23 lows.
What explains this difference? A common bet: the current data on the economy is terrible but it should improve.
1. Betting on a “V” recovery
Many analysts are looking beyond the grim economic data, anticipating a rapid recovery as state economies open up across the country.
New York, which has been hit hardest by the pandemic, has started to develop a plan to revive its economy. Other states are more advanced, with more than 20 authorizing the reopening of certain companies. Nevada Governor Steve Sisolak said that some businesses, including restaurant dining, would be allowed to reopen on Saturday with social distances and occupancy limits. These measures have encouraged investors to think that the economy is ready to rebound quickly in early 2021.
In addition, the number of new cases of Covid-19 has decreased in the United States and stocks have surged at any sign of progress towards a potential vaccine.
“People are betting … that’s the bottom,” said R.J. Grant, director of equity trading at KBW. Yet he said, “The market is really out of touch with the economic reality right now.”
In addition, many investors said Friday’s unemployment figures and other disappointing data were not a surprise after the data for the past few weeks showed a flood of people claiming unemployment benefits.
Yet analysts are watching for tiny signs that the bottom of the economic slowdown is near.
Goldman Sachs Group Inc.
analysts tracked various metrics such as demand for gas,
mobile app downloads and restaurant traffic measured on the OpenTable booking site to detect signs of recovery. Demand for gas, although it has dropped significantly, started to improve in the past week, while other work and public transit data tracking flows showed weak earnings as some states reopened.
“There are early signs that life is returning to normal,” analysts said in a research note on Thursday. “We expect these little signs of recovery to continue as the country gradually reopens and consumers resume their daily activities.”
2. Market leaders continue to grow
The stock market is increasingly divided between the haves and have-nots, and the recent rally reflects the outperformance of a handful of stocks. Large technology companies, which are heavily weighted in the indices, were behind much of the rebound, continuing a trend that has prevailed for almost 11 years in the bull market.
“The whole market is not on the rise,” said Giorgio Caputo, portfolio manager at J O Hambro Capital Management, who said his company had increased its stocks in recent months. “This is the best time for some companies. It’s the worst time for other companies. “
Five major technological titles –
Inc. – together account for about 20% of the S&P 500. These companies took advantage of the fact that Americans in the country took shelter from the pandemic at home, spent time on social media and ordered essential items at home such as online grocery shopping.
Amazon and Microsoft are leading the way, with gains of 29% and 17%, respectively, this year.
At the same time, the entire energy sector constitutes roughly 3% of the general stock market index. This means that the companies that have suffered the most have little influence on the direction of the market. The energy sector is down 35% this year, in conjunction with a drop in oil prices, making it the worst performing group on the market.
Another way to measure the oversized influence of the largest stocks: the S&P 500 is down 9.3% this year, while a version of the large stock market index that gives each company an equal weighting was even more beaten , down 16.8% this year, FactSet data shows.
The growing divergence between the winners and losers of the market reintroduces another risk: a sudden exodus of the darlings of technology could easily drive the market down. Analysts expect a lot from their growth, so any perceived disappointment will weigh heavily on the entire market.
3. Business profit expectations remain high
The profits have been catastrophic and the coronavirus has already pushed companies from J.Crew Group Inc. to Neiman Marcus Group Inc. and
Offshore diamond drilling
Inc. bankrupt. But investors are counting on a rapid rebound.
Profits are expected to drop 14% in the nearly finished first quarter earnings season, the largest drop since 2009, according to FactSet, before dropping further later in the year. Analysts project profits will bottom out in the current quarter with a 41% drop – and a 13% increase in the first quarter of next year.
“While the earnings outlook will remain disputed at least [the first half of 2020], investors are increasingly putting the success of Covid-19 back to fundamentals this year and looking to a recovery in 2021 “,
& Co. analysts wrote in a note recently. They added that they were optimistic about stocks and expected to return to previous highs by the first half of 2021.
4. Old habits die hard
Another fear among some investors is missing a faster than expected recovery.
The measures taken by the Federal Reserve and the United States government to support the economy have been far-reaching and have so far attracted investor confidence. If the stock market bullish ends up being the reason for a rapid recovery and the economy starts a strong rebound, this would leave other investors behind a potential market rally, missing the gains.
And as has often been the case in recent years, investors find themselves faced with few attractive alternatives if they refuse to bet on stocks. The problem is so familiar that it has its own acronym: TINA, or there is no alternative to actions.
“This creates a bilateral risk for this equation for investors,” said Jim Paulsen, chief investment strategist at the Leuthold Group. “The virus may continue to burn. There is also a risk on the other side. “
Treasury bill yields are near their lowest levels and the corporate bond market has recovered since the Fed released its stimulus package. This means that the returns of top companies also remain low. Some investors have even started betting on negative interest rates in the United States.
“Where are you going to put your money to earn a return?” asked Mr. Grant of KBW. “People are scratching their heads.”
The yield on the 10-year Treasury bill stood at 0.679% on Friday, while the dividend yield on the S&P 500 is around 2%.
5. Fed support
Fed and US government measures have supported the recent market rally. The Fed has made it clear that it is ready to intervene to support the economy. Why bet against the market when the central bank is ready to do so?
“You can’t forget the amount of politics that is under the stock market,” said Mr. Paulsen.
Write to Gunjan Banerji at [email protected]