Why is the Stock Market Going Up When Everything is So Bad?
In the midst of all that’s going wrong in the world, it may seem entirely counterintuitive that the stock market is maintaining a strong performance, and even hitting all-time-highs.
We’re witnessing a global pandemic, record economic contraction, job losses and social unrest, so why is the stock market still going up instead of falling in sympathy with everything else?
There are many factors that account for the discrepancy between the real economy and the stock market. Here are the most dominant reasons:
1) Beating Out The Competition
COVID-19 was an unprecedented global pandemic, so it took an unprecedented level of fiscal and monetary stimulus to address the fallout due to the lockdown measures. The US Federal Reserve cut interest rates to near zero and increased liquidity (the amount of money circulating in the economy) by ramping up its bond-buying program. To add some perspective, it’s more than twice the increase in liquidity in the entire year that followed the Lehman bankruptcy that’s being injected into the financial system.
Because of lowered interest rates, interest-bearing securities (such as bonds) are less attractive, and stocks are more attractive. By default, the stock market has essentially beaten out the competition when it comes to where to invest money right now.
While it may seem like the stock market is rising due to irrational exuberance — unfounded market optimism that lacks a real foundation — it’s actually a very rational occurrence on the part of investors who are choosing to put their money where they get the best return.
2) Supply and Demand
The huge increase in liquidity adds another element. There’s trillions of dollars in the global financial system chasing after the finite assets available to invest in. While the demand for stocks is increasing (due to the increased liquidity in the market and the less attractive returns on bonds), the supply of stocks has been decreasing due to share buybacks by major companies over the past 5 to 10 years.
As it goes, the value of something increases when the demand for it far exceeds the supply.
3) High Weighting of Tech Stocks in the Index
When investors refer to “the market”, it’s usually in the context of the S&P 500 index. This is an index of 505 large companies in the US that’s used to gauge the overall US stock market performance.
While it may seem as though the stock market is brushing off the bad news and rebounding to new highs, it’s worth mentioning that the rally hasn’t been broad based. The vast majority of stocks are still stuck down in the doldrums of the March sell-off and are struggling to recover to their pre-pandemic levels.
This rally is largely driven by Big Tech — Apple, Amazon, Google, Microsoft and Facebook — whose combined value makes up a quarter of the entire S&P 500 index. Because the S&P 500 is a market-capitalization-weighted index, the stocks that have a higher value that make up the index get a higher weighting to determine the overall value of the index.
So, while most of the companies in the S&P 500 are still below their pre-pandemic levels, the overall stock market appears to be performing well due to the over-performance of the tech stocks that investors have favoured during the stay-at-home measures.
4) Increase in Retail Investors
One effect of the pandemic lockdowns was the rise of “entertainment investing”. People who would otherwise bet on sports or at the casino switched over to betting on the stock market when those other avenues were closed.
Retail brokerages experienced major increases in new account openings — showing the added interest in individuals investing in the stock market during the pandemic.
Young people have also been lured into the stock market through social media “influencers” on apps like TikTok and YouTube, who encourage their followers to open accounts on Robinhood and trade in the stock market.
Retail investors accounted for as much as 25% of the stock market’s activity in the months of lockdown — compared to just 10% of the market in 2019.
And while some retail investors bet against the market, the majority tend to invest in the market or trade in call options which pushes the value of the S&P 500 higher.
As can be seen, there are a variety of factors that can be attributed to the stock market’s performance that aren’t reliant on news from the “real world” itself. Next time you see the stock market at a high when everything else is crashing around you, you may have an inkling as to why.
The information contained in this article is not intended and should not be used or construed as an offer to sell, or a solicitation of any offer to buy, securities of any fund or other investment product in any jurisdiction. The information in this article is not intended and should not be construed as investment, tax, legal, financial or other advice.
