I want to add emphasis on (2). The effects are not spread out uniformly across all businesses. The hard hit businesses including restaurants, bars, and hair and nail salons have seen almost all of their business evaporate. You're not going to find the corner nail salon in the S&P 500.
The employees of these businesses also consume products from large cap companies. Who is going to buy things if they’re out of work?
I'm not without hope, but I fear we're going to see a lot of otherwise great businesses (breweries, bakers, barbers, spas, bars, restaurants, etc) go under and not get replaced by businesses of the same caliber anytime soon. If my barber closes I'll keep cutting my own hair. Same with my favorite local bakeries, restaurants, breweries, etc. I certainly won't start eating Applebee's microwave dinners and sugarritas just because they're the only joint in town.
I've diverted a significant portion of my savings due to this pandemic towards my retirement, but that actually has a small deleterious effect on my local economy as it is not strongly exposed to greater market forces as I'm reducing the volatility of money in my locus. I'm sure that I am not be the only one making choices like this.
A related assumption is also that government bonds will be a less attractive alternative place for investors to park their money.
And the only thing that can explain where the stocks are now is that the Fed has pushed 2 trillions of liquidity into the market in matter of weeks, which is just unprecendented (the previous QE were much more gradual) and that lifted all asset classes.
But at one point stock prices will need to get back in line with earnings. I don't really hear anyone talking about v-shaped recovery anymore.
That's not entirely true, the composition of the S&P500 has pretty dramatically changed in the last few months[1].
If you look at the linked chart most sectors are down — energy is -50%, consumer discretionary is -27%, financials are -22%. However, a few sectors are up — healthcare is +5%, consumer staples +6.5%, information technology is +8.5%.
So with shelter-in-place and quarantine, it makes sense that the world's demand for oil and travel is at all time lows, and the stock prices reflect this. Instead, the demand is now almost entirely online, on the internet. Nearly every IT sector company is surging.
Even real-estate is down, as expected (fewer moves happening, less commercial leasing), but it appears to have a high variance[2]. Why is that? There are actually a few real estate companies on the S&P that are doing really well: $SBAC (operates wireless infrastructure), $EQIX (specializes in datacenters), $AMT (wireless and broadcast communications infrastructure), and $CCI (shared communications infrastructure).
So, many sectors of the economy are down, as are most companies. The current pandemic has pushed more capital to businesses which operate online. So the reason why the market cap of the S&P500 hasn't changed dramatically is because the distribution of the money underlying it has. The S&P500 is a capitalization-weighted index.
> But at one point stock prices will need to get back in line with earnings. I don't really hear anyone talking about v-shaped recovery anymore.
This week a lot of tech companies are reporting their earnings. Alphabet announced a 13% increase in revenue. If other tech, communication infrastructure, consumer staples, and personal health companies report similar earnings, then this whole thesis will be validated: the S&P500's current market value can largely be attributed to a flight-to-quality, where the "quality" is pandemic-proof stocks.
That's super interesting and makes a lot of sense. However, could you elaborate a bit further? Suppose we have an S&P 5, if the top 5 companies remain the same, but they on average do worse, we'd see the S&P 5 go down. You seem to imply, if I understand correctly, that the S&P 5 is not down as much because 1 company did really well and stayed, 4 that did poorly left and got replaced by 4 companies that did really well, too. Thereby the S&P 5 changed its composition.
And that makes some sense. However, that would mean that if you had an all-world or all-us stock indexes, which did not exclude any companies dropping out of a top 100 or top 500 or whatever, would have to see a large drop.
And I'm not really seeing that. These stock indices track roughly the same shapes as the S&P500, with perhaps few percentage off, but nothing substantial.
No that's not what's happening. Think of S&P 500 index as a basket of stocks. What does that basket look like? If I buy one "unit" of this basket, does it include 500 shares of stock, across the 500 companies? NO. The distribution of the basket is weighted, and it's weighted by market capitalization. So if all stocks were worth the same, you would have a unit amount of every single stock. But if, say, 5 companies do really well and 5 companies do really poorly, 1 "unit" of the S&P500 basket will actually include more of the "really well" stocks, and less of the "really poorly" stocks. The capital is automatically reallocated based on the market capitalization. Because of this, the market value of the S&P500 has stayed relatively stable.
> And that makes some sense. However, that would mean that if you had an all-world or all-us stock indexes, which did not exclude any companies dropping out of a top 100 or top 500 or whatever, would have to see a large drop.
Again, that's only true if this index is naive enough to not apply any sort of weighting. Most indexes in the world are weighted indexes, in fact we are generally instructed that indexes that do not apply any sort of weighting are bad indexes.
So, down 10% from the previous bubble.
> 2. S&P is heavily weighted towards the strongest companies
Good point. Dow is also up almost as much though.
> 3. The market is always very forward looking.
I may be cynical, but I see perhaps 2 to 3 years to regain the jobs we are losing, to see the employment rate return to earlier levels. That's years of depressed spending, and all the other woes of society from high unemployment.
So the market is looking to, what, 2025 or something?
Sorry to pick on you, I still just don't get it.
Sure. People are basically betting that stock prices are cheap right now, and if they hold onto them for a few years they'll be back to where they were.
Look at the 2008 recession. If you bought then you'd be doing very well.
They're basically betting that the worst has already been priced-in. In a sense, they're probably betting that we won't get a totally calamitous re-opening of the shutdown, or a totally calamitous fall and winter next year. But, in any case, most people adhere to the idea that stock prices always go up eventually, and therefore they buy accordingly.
We're about to hit bedrock, I suspect.
Interest rates are negative or near zero, so bonds have the risk of losing value as interest rates rise, as the Fed needs to fight inflation. They also have no real upside, since interest rates are so low.
The Fed has agreed to print unlimited money to prop up businesses that basically don't exist, so having a bunch of cash is not safe, since the Fed is printing so much more of it.
So grossly overvalued stocks may be the best thing now.
Well, another point not mentioned is, where else are you going to park your money? Interest rates globally are basically <= 0, real estate may be a dicey proposition for many years to come, bond yields are garbage, so... stock market. And considering so many companies are selling at a discount (regardless of whether or not you think that’s the case), dumping money in the stock market is a pretty good bet right now.
Long-term these problems should work themselves out and real estate (particularly in hot coastal metros) should start going up again, but 2020-21 is going to be rough.
And as always the stock market isn't anywhere near a holistic view of the economy, it just gets over used because it's a convenient constantly updating number that can get slapped beside any news cast or announcement.
The dow is a subset of large companies in the S&P.
I would also add a #4 to your list that people often miss. There is risk and there is uncertainty (think unknown unknowns). The market hates uncertainty because it is so hard to price. Risk though can be priced. This is often why the market will go up with numbers that look really bad when they come in. They are no longer uncertain.
In a mathematical sense, the relationship isn't as much between the absolute level of the economy and prices, it is the tendency of the economy and the prices. You should look at the first (maybe second?) differentials.
Furthermore, values like GDP are inherently lagging. They show data that has happened months ago. There's almost no new information content in that number. Yes the number is bad, but everyone knew it's going to be bad. It sounds like (judging by the market action) that it wasn't worse than consensus.
Now, all the above is viewed through a lens of efficient markets. Reality is again more complex. As it has been pointed out, the price is not just driven by expectations about the economy or stocks, it is very much driven by central bank and government action. Easy money distorts prices. When Tesla which makes a puny 400k cars a year and has just about stopped being loss making is priced higher than VW which makes >6 million cars a year and made $17 billion, something is off. Let's put that into context, Tesla shares have priced in decades of non-stop geometric (20% YoY) sales growth to justify the _present_day_ valuation.
Don't think for a moment that traders don't know this. It's absolutely a game of musical chairs and they know it. Everyone, and I repeat, even the most boring, backwater pension fund board knows that this is a bubble. Everyone is participating and hopes that when the music stops, they'll have already made some safe haven stockpile to weather the storm.
The downside for those companies will be the regulators at DOJ. I have no doubt they will survive this pandemic in even better shape than before. The question then is if the government will work to break them up.
Obvious examples would be splitting YouTube from Google, splitting Instagram and WhatsApp from Facebook and forcing Amazon to pick a side (own the marketplace or be a seller).
https://www.federalreserve.gov/monetarypolicy/bst_recenttren...
It is no harder to inflate the dollar than any other currency. Print enough of them, and the their price will go down. It's no different from any other commodity.
If you increase the reserves, you are forcing the interest rate down, so you are making credit more cheaper (until it arrives zero and can't go further down).
For inflation to appear you need borrowers to who the banks think is good business to lend, and that spend that borrowed money in the economy. That it's not going to happen in a depression, when nobody wants to invest and the banks are scared to lend.
What is necessary is a decisive fiscal policy. That would increase the central bank balance sheet also, but what would cause some inflation would be the spending in the economy, not the number in the balance sheet.
But that is NOT what is happening at the moment. What is happening at the moment is almost the exact opposite: money is being injected mostly at the top in order to prop up asset values, with a little bit coming in to the bottom via the $1200 relief checks, and the middle via PPP.
But it is simply not possible to keep pumping currency into a shrinking economy without producing inflation. Sooner or later the law of supply and demand will catch up with you. The only question is whether it will happen before or after November.
For everyone who will respond "oh but CPI has a housing component": https://slate.com/business/2014/02/housing-inflation-the-cpi...
I thought I'd look up the performance of various indexes for the past month (as of the time I looked them up):
* S&P 500: +15.2%
* Dow Jones Industrial Average: +14.1%
* Nasdaq Composite Index: +17.9%
* Russell 2000: +21.7%
* Russel 3000: +16.0%
* Wilshire 5000: +16.3%
I then looked at the YTD, and didn't bother comparing them because they all essentially looked identical to one another.
Note that the DJIA and NDQ are mostly contained within the S&P are they are highly correllated. Weighting aside (I'm not actually sure what differencs their might be), the S&P is contained in R3k and W5000, but not R2k.
So no, I don't think the idea that Apple and Facebook are doing well (thus keeping hte S&P numbers inflated) holds weight. In fact, the Russell 2000 does not include the top 1000 companies (like the Russell 3000) and shows the highest return for the past month.
Rather, it seems like all of these indices are correlated. It reminds me of the Hillary Clinton autoregression of prediction markets during the 2016 election: immune to new information.
The easiest, and best, comparison for this is to look at the S&P 500 vs an S&P 500 equal weighted index (where all stocks are weighted equality, instead of weighted based on market cap). Over 3 months (i.e. just before the market peaked) the equal weighted index is down almost 15%, while the market cap weighted index is down just over 10%. This is clear evidence the larger companies are significantly outperforming the smaller ones.
The market incorporates news quickly, such as that there is a pandemic and it is going to have bad effects. Then it essentially forgets about it. I suspect most of the 12% is a response to government actions to control the pandemic and to the recent news that it is coming under control. You will see another drop if relaxing controls leads to another covid spike, and when economic effects appear on corporate financial reports, and when long term job losses are reported. Those are perfectly foreseeable, but in the meantime the market will likely go up as the memory of why they went down in the first place fades.
April is in Q2.
A key detail from the Alphabet earnings: there appeared to be different performance trajectories for the brand and direct response components of their advertising. Direct response continued to have substantial year-on-year growth throughout the entire quarter — can be explained by brands now directly reaching people at home under quarantine. Brand advertising growth accelerated in the first 2 months of the quarter, but began to experience a headwind in mid-March. Snap's earnings call appeared to include the same observation, from Evan Spiegel: "In the short-term, we are shifting sales resources and pulling forward some investments in direct response to better serve the advertisers who are trying to reach our audience during this time…".
Additionally, Alphabet obviously also makes its money through Google Cloud Platform, whose compute usage will continue to pick up as more and more people consume online content at home. The net argument is that, even in Q2, Alphabet might come out looking stable because it is not as exposed to the downsides of COVID as, say, Twitter or Facebook.
THAT is what I mean when I say "we'll see".
At the moment, the stock prices of health care are up +5%, consumer staples +6.5%, and information technology +8.5%. Energy is down -50%, consumer discretionary -27%, and financials -22%. Due to this, the composition of the S&P500 has dramatically changed, most of its underlying capital is now in higher priced assets in the former list, rather than the lower priced assets in the latter list. Because the S&P500 is a capitalization-weighted index, the total market value reflects this.
Honestly this is all just a giant advertisement for investing in index funds.
The market doesn't need to reflect the reality when you have an excess of cheap cash on the market.
This is despite the economic slow down as B2C companies losing 20-100% of their customers and B2B companies lose their B2C customers who no longer have income.
"Sales of monitors increased by 73 percent compared to last year, PCs were up 53 percent, printers were up by 61 percent, and microphones were up by a massive 147 percent. Chromebook sales are also reportedly seeing triple-digit sales increases, which makes sense given how popular they are in classrooms.
Underpinning all this tech is a 70 percent increase in the sale of networking equipment. Although not detailed in Baker’s tweets, we’ve also seen a shortage of webcams, leading to skyrocketing prices."
It does look like some businesses besides medical equipment manufacturers have benefited. I'd be shocked if other things like sewing machines haven't seen huge growth in sales, also.
It's also at the same level as one year ago. The economic situation, and outlook, is surely worse than one year ago? What has improved is the Fed inclination to make it true that stonks can only go up.
1. People keep saying about the market being up recently, but skip the part about it still being down about 10% since the start of the year.
2. S&P is heavily weighted towards the strongest companies. Amazon, Apple, Facebook, Microsoft and Google account for 20% of S&P market cap. Most of those companies have been helped by the pandemic, or at least not hurt nearly as bad as smaller companies.
3. The market is always very forward looking. It is essentially betting that things are as bad as they'll get. I don't know if I personally necessarily agree, but if you look at countries starting to open up it's not an unreasonable bet.