Markets dismiss pandemic fears in bold bet on quick recovery

Markets have rebounded since an initial dive during the coronavirus pandemic, recovering more than half their losses and raising questions about their seemingly oblivious reaction to an onslaught of dire economic projections. 

Take the S&P 500, an index considered to broadly represent the market, which closed Friday at 2,836.70 points. That is down some 16 percent from the all-time peak of 3,386 in mid-February, but it’s also nearly 30 percent higher than the 2,191 low point it reached in March.

The index’s current level is the same as it was in January 2018, when stock investors were giddy.

Back then, President Trump had just signed the GOP tax law, the economy had closed out a year at a comfortable 2.3 percent growth rate, and unemployment was at 4.1 percent and headed toward a 50-year low. 

Today, the world is grappling with the global coronavirus pandemic, gross domestic product is expected to shrink by 5.6 percent and unemployment has risen to levels not seen since the Great Depression. The Congressional Budget Office estimates it will hit 16 percent next quarter and will average 10.8 percent through 2021. 

During the Great Recession, unemployment peaked at 10 percent, and that lasted just one month.

Yet having recovered more than 20 percent since its trough, the S&P 500 has thus far become the shortest bear market in a century.

Some investors, however, reject that markets are disconnected from the real economy.

“I don’t agree at all,” said Chester Spatt, a professor of finance at Carnegie Mellon’s Tepper School of Business.

Stock markets, he said, are about the future, not today.

“The stock markets reflect expectations of long-term values and long-term cash flows. So the stock markets are making an assessment of what is going to happen over time, not just what’s happening next week,” he said.

Another key difference between today and early 2018, he said, is that interest rates have dropped to near zero after the Federal Reserve cut them in an emergency action last month.

Low interest rates tend to inflate asset prices, including stocks, so that could account for some of the higher valuations.

Other investors acknowledge the market’s swift rebound is unusual but still see some justification.

“I’ve been a little surprised by the strength of the rally in recent weeks given that we still face a large amount of uncertainty in the next several months,” said Michael Sheldon, executive director and chief investment officer of RDM Financial Group at HighTower.

But Sheldon said one reason markets may be discounting the daily onslaught of horrific economic news is that investors don’t want to be locked out of a recovery.

“These are all really bad numbers. However, one thing to keep in mind is that the markets have historically rebounded before the economy,” he said. 

“If you wait for the economy to rebound as an investor, you’ve probably missed a lot of the upside,” he added.

Another major difference is that Washington has moved far more swiftly to contain the economic fallout of this crisis, passing trillions in emergency funds and fiscal relief while rolling out trillions more in borrowing through the Fed. 

“As a result of the massive policy response from Washington and the Federal Reserve, the worst-case scenario for the economy seems less bad than it did a few months ago,” Sheldon said.

Having a playbook from dealing with the global financial crisis helped Washington agree on bigger measures more quickly than the last time around. So did the seeming disappearance of concern over debt, which kept the 2009 stimulus relatively constrained.

But others say the markets may be overvalued given the extent of the current economic calamity.

Mark Zandi, chief economist at Moody’s Analytics, says investors may have been too quick to accept the idea of a V-shaped economic recovery, in which a fast decline is followed by an equally fast rebound.

“Given the high level of uncertainty, investors may be putting a higher weight on a V-shaped recovery than you or I or others might, especially because their horizon might be short,” he said.

While a quick recovery remains a possibility, it does not account for the possibility of a slower road to reopening the economy, prolonged problems with testing or contact tracing, the possibility of additional outbreaks down the road, or delays in developing a vaccine — all of which public health experts say are very real possibilities.

Even without those potential hurdles, the current process of opening may be less straightforward than some are assuming.

In a Thursday blog post, Bill Gates described a “semi-normal” process of opening up in which people went out sometimes but not often, avoided crowded spaces, ate at restaurants that kept tables six feet apart and flew on half-empty airplanes.

The economy may not be able to operate very well on that level, he noted.

“For example, restaurants can keep diners six feet apart, but will they have a working supply chain for their ingredients? Will they be profitable with this reduced capacity? The manufacturing industry will need to change factories to keep workers farther apart,” he said.

“But how do the people employed in these restaurants and factories get to work? Are they taking a bus or train? What about the suppliers who provide and ship parts to the factory?” he added.

Zandi said the markets may not have priced in these sorts of eventualities.

“I don’t think they’re properly discounting those other, darker scenarios,” he said.

During turbulent times, he added, different kinds of investors tend to be more active in the markets. While long-term investors may be waiting for clearer signs of a recovery, short-term traders are still trading more actively.

“They’re really short-term focused and are playing it from a trading perspective and not an investment perspective. So if you do that, it’s not unreasonable to expect the economy is going to bounce in the next few months,” he said.

In that kind of environment, he said, the market can become “more of a mechanism for placing bets.” 

But the most important point, Zandi said, is that it’s still early days. During the global financial crisis, it took well over a year for the markets to go from their peak in late 2007 to their trough in early 2009, with ups and downs in between.

“The script’s still being written. Markets go up and down and all around, and I don’t think we’ve seen the entire story written. So stay tuned,” he said.