by Ralph Cole, CFA
Director, Equity Strategy and Portfolio Management
Why?
After the best month for stocks since 1987, the headline in the NY Times read, “The Bad News Won’t Stop, but Markets Keep Rising.” I have received many questions from many clients and friends over the past couple of weeks regarding this notion. We believe that there are three reasons why the market has been so resilient: 1) fiscal stimulus, 2) monetary stimulus and 3) the forward-looking nature of markets.
Come Together
At a time when partisanship seemed to be at its peak in Congress, the coronavirus was able to bring the parties back together. In just a few short weeks, Congress has cobbled together $2.6 trillion in stimulus for the U.S. economy. Through loans, increased unemployment insurance and stimulus checks, congress has shown urgency in dealing with the fall out of a global pandemic. What seemed impossible just a few short weeks ago has now come to fruition and given the markets confidence that Congress is ready to support businesses and workers in this very difficult time.
The fiscal stimulus (increased government spending) has not just occurred here in the U.S. — the response has been global. In all, developed market economies have dedicated fiscal stimulus that averages 10 percent of their GDP, by far the most amount fiscal stimulus ever tried. This has given global markets comfort.
Monetary Stimulus
One form of monetary stimulus is called Quantitative Easing (QE). QE occurs when the central bank of a given country buys securities in the open market to provide liquidity to that market. The QE efforts on the part of central banks at this time has been massive. Below is a chart that shows the change in central bank balance sheets over the prior 12 months. You can see the steepness and scale of the response to the coronavirus.
Sources: Haver Analytics and Morgan Stanley Research
By providing liquidity in the mortgage bond, municipal bond and Treasury markets the Fed has lowered interest rates and assured proper functioning of those markets. Functioning markets have given investors the reassurance that if they need to buy or sell a given security, there is adequate liquidity to do so. Without central banks stepping in these markets may have frozen and that is when panic would begin. Swift and diverse action by central banks has also been encouraging to global markets.
Hope
Finally, the markets are higher because they are forward-looking. We will eventually be able to open our economy, and business will return. We understand that nobody knows when it will be, but we know it will happen. Stocks by their nature are anticipatory, and are valued by their long-term earnings, not just the next quarter. This valuation process is what we are currently experiencing. How much long-term damage has been done to our economy? How has the pandemic changed various industries? And, eventually, what are investors willing to pay for those stocks? This is occurring daily throughout markets on a global scale.
We believe that the rapid response from central banks and global governments has allowed investors to look beyond the daily negative headlines and start thinking about the future two-to-three years down the road. Without the fiscal and monetary stimulus, markets would not be able to look ahead.
Week in Review and Our Takeaways
Global fiscal and monetary stimulus have given hope that business can return to normal after the coronavirus has run its course, in whatever fashion that may be
Daily gyrations in the stock market are simply investors trying to gauge long-term stock valuations during an inherently confusing time