It has been nearly 3 months since the S&P 500 Index reached its annual low of 2237.40 on March 23, 2020. With the novel COVID-19 continuing to stall economies at a global scale, several state authorities have authorized local stores and businesses to re-open, concerning the fact that quarantine cannot stall the economy indefinitely. According to the US Labor Department, 36.5 million U.S. citizens have filed unemployment claims over the past two months. With stores and businesses having just opened recently, the situation is still dire. Nevertheless, the stock market is doing greater than expected: As of June 19, the S&P 500 recorded a value of 3097.74, recovering almost 90% of the value that was recorded before the steep decline that happened mid-February.
Why is the stock market doing great, unlike that of the economy? In economic terms, this is called “decoupling,” which refers to a disconnect between a country's investment market performance and the state of its underlying economy. The question, having been debated by experts ever since the stock market started to mend itself, is puzzling to many investors, which has them caught between two schools. It may be beneficial to examine the analysis presented by Howard Marks, who is regarded by many as a legendary investor, in his most recent memo: The Anatomy of a Rally. In the memo, Marks provided insight on what might be the underlying causes for this phenomenon.
For starters, Marks deems that optimism may be the cause-- investors are “looking across the valley” at better times ahead of the situation. For instance, he believes that investors may suppose the Fed (Federal Reserve System) is doing a great job mending the economy. The Fed and Treasury took steps such as lending more money to small businesses and individuals; many investors may be convinced, although the recovery will likely be gradual, that recovery is a sure thing. Moreover, he is convinced that investors believe the pandemic is starting to relent as the number of daily COVID-19 patients in the U.S. is gradually declining. According to the CDC, the number of patients recorded on June 1 was 14790 patients, which is relatively low compared to that of April and May. By this, investors may have anticipated that the pandemic would resolve quickly. Additionally, he suspects that investors are prospecting for the future; they believe that, with great possibility, things will get better in 2021 and 2022.
Marks also emphasizes the impact of behavioral factors. For instance, he mentions FOMO (fear of missing out), a concept that is commonly studied in behavioral economics. Individuals would not want to miss valuable opportunities to create profit, anticipating greater participation in the market. He also believes that investors are cheered by the fact that the Fed seems to be offering a “Powell put,” a successor to the “Greenspan put” of the late 1990s/early 2000s and the “Bernanke put” induced by the Global Financial Crisis. Investors are assured that the Fed, without a choice, will keep markets levitated in order to reassure financial market participants. Another widely held theory is that government benefit checks have influenced investors’ purchases. Since the pandemic has shut down sports, sports bettors have only one casino to play in: the stock market.
On the other hand, Marks also mentions a series of negative factors that may not particularly favor investors: the possibility that an effective vaccine will not be developed as early as people anticipate; the likelihood of a second outbreak, as a result of a premature opening of the economy; and the impact of increased inflation or deflation, or a long-term damage to the reserve status of the dollar that may occur. Marks believes there are always positives and negatives, and it is crucial to determine which investors weigh most heavily when it comes to determining market behaviour. Certainly, investors have been weighing more on the positives.
Marks concludes that the current rally is based on investors’ optimism that the economy will show its resilience, the neglect of negative factors that may contribute to the market, and the belief that the fiscal policies that the Fed and Treasury are implementing will successfully mend the fundamentals. “In other words, the fundamental outlook may be positive on balance, but with listed security prices where they are, the odds aren’t in investors’ favor.”