4 Lessons We Can Learn From The Stock Markets' Bull Charge Reaction To The COVID-19 Pandemic

2021 is a year of unprecedented volatility having a global pandemic and global recession. From 19 Feb 2021 to 23 Mar 2021, the S&P 500 has dropped 33.9% in just 33 days, and recovered in 11 weeks. This is the swiftest market crash and recovery ever. In comparison, the Global Financial Crisis took almost three years to recover. What can we gain knowledge from the stock markets' reaction to the pandemic?

#1 Stock Markets' Recovery Aren't Equal

In general, most people use the term 'stock market' to consult the stock markets in general. However, it would be a misconception to consider that stock markets are homogeneous. Each stock exchange has its own stock exchange which comprises of different listed companies.

The truth is that the recovery is not the same for all stock markets. Our local stock exchange, the Straits Times Index (STI), hasn't staged a recovery as robust as the S&P 500. As of 16 June, the STI is still negative 17.9% from the start of the season, while the S&P 500 is just down 5.9% and the NASDAQ is really positive 10.8%.

Similarly, the Asian stock markets show unequal performance, with China and Hong Kong leading the recovery. While the Nikkei and STI have recovered from their lows, their recovery is not as strong as compared to the Hang Seng Index (HSI) and the FTSE China A50.

If you have been investing in the overseas stock indices, you would have seen a better recovery out of your investments than the STI.

Lesson learnt: There's value in diversifying your investment beyond the Singapore Exchange.

#2 The Stock Market Is Not Necessarily A Reflection Of The Current Economy

To some, it seems unimaginable that the stock markets are continuing their blistering rally as dire economic data continues to be released. The conflicting headlines, for example “Nasdaq hits record high as U.S. recession becomes official”, does not seem to make sense to most non-investors and even some investors.

However, keep in mind that the stock exchange is not the economy. Instead, very often, the stock market is a reflection of the expectation of future earnings. Stock values rise and fall, depending on the expectation of if the company's earnings would be negative or positive. This means the stock market may price in the expectation of a v-shaped recovery where economic activities will resume, and companies will be able to meet their earnings forecasts.

The other indicate remember is that economic data are lagging indicators. Macroeconomic data, such as unemployment data, are collated and released later, with at least a month's delay. Instead, economists are starting to turn to alternative real-time indicators for example Google Map data, booking reservations and e-payment volumes to possess a better sensing of consumer and business sentiment.

The stock exchange is also blind to individual economic hardship and socio-political issues that have no impact on earnings. While George Floyd protests are taking place in the USA, the stock market continues its rally without pause. Likewise, for that millions who have lost their jobs, the stock exchange rally is of little comfort.

Lesson learnt: Stock markets are forward-looking and can be agnostic to current events.

#3 Stock exchange Performance Is Driven By A Few Stocks

The stock market's performance starts to make sense when you look at the individual stocks that comprise the index. The top 10 constituents from the S&P 500 (forming 26% from the index) on 15 June 2021 are Microsoft, Apple, Amazon, Facebook, Alphabet (Google), Johnson & Johnson, Berkshire Hathaway (owned by Warren Buffett), Visa and JPMorgan. These are mostly technology companies plus some finance related companies who aren't as badly affected by the pandemic and perhaps, may even be seeing some growth.

As individuals are confined at home, technology companies like Microsoft, Apple, Facebook and Alphabet are thriving as people turn to digital solutions and communications. Amazon continues to be able to generate revenue at home deliveries. Visa is riding an upswing of e-payments. When you realise that the overall stock index is driven by the massive movement of a few major stocks, the recent stock market rally begins to be preferable.

Lesson learnt: Stock market performance could be driven by the outperformance of a few major stocks.

#4 The Stock Financial markets are Flush With Credit Stimulus From Central Banks

The Federal Reserve (Fed)'s stimulus is the major trigger for the market rally following the markets crashed due to coronavirus-induced fears. Actually, the announcement of the Fed stimulus measures on 23 March 2021 marks the turning point of the market movement.

In line with the Fed, other central banks have also implemented huge stimulus packages and lowered interest rates. Singapore has also implemented the Resilience, Solidarity and Fortitude Budgets to the tune of $92 billion to support the country economically through the crisis.

Central banks typically implement stimulus measures through lowered interest rates, asset buying and other programmes that try to increase credit liquidity within the monetary system. This makes it easier for businesses to take loans to tide them through rough periods.

The Fed comes with an outsized effect on global stock markets when compared with other central banks. This is because of the US dollar's role as the global reserve currency and since the US stock market is the largest stock market in the world. US stocks constitute more than half (54.5%) of global stocks, followed by Japan at 7.7%, UK at 5.1% and China at 4% (as of Jan 2021).

While the Fed doesn't participate directly in the stock market, the Fed has enlarged its bond-buying powers by expanding the amount of bonds ($3 trillion in loans and asset purchases) and also the type of bonds the Fed buys (from bond ETFs to individual investment grade corporate bonds). It has led to a drastic drop in bond yields.

Traditionally, bonds and stocks are inversely related: when stock values go up, bond prices drop and vice versa. The economic logic behind this really is that investors have to choose from the safety, but relatively low return, of bonds, or the risky nature, but relatively high return, of stocks.

However, due to Fed intervention, we are seeing an instance where both bond and stock prices are high. Due to the Fed buying bonds, bond yields have dropped to historic lows, while bond prices have risen. Looking for better yields, investors have piled into stocks, further pushing up stock prices, leading to the stock market rally.

This is going on globally as central banks have injected monetary stimulus to soften the economic impact of the pandemic. The outcome of stimulus on stock performance is so significant that the market observers have coined the term “Powell Put” to refer to the point below which Fed Chairman Jerome Powell wouldn't let the market fall before stepping along with stimulus.

Lesson learnt: Do not underestimate the impact of monetary policies on stock market performance.

With these lessons learnt, investors will need to keep vigilant and balance both risk and opportunity. Once we enter Phase 2 of Singapore's reopening, we have to keep in mind that we have not seen the last of COVID-19, both in Singapore and around the world. Thus, it is still unknown how the stock market will play out through the rest of the pandemic.