Why is the stock market rising?

At some point in the last two months, investors must have pondered the question of whether the stock market has become completely detached from the real world. With all the misery brought about by the coronavirus pandemic, the many deaths, the millions of lost jobs and the slump in demand and trade, we are left wondering how it can be possible that April 2020 was Wall Street’s best month in decades and that the Nasdaq index has just seen a new record high (intraday on 4 June 2020). As we can conclude from Michael Steinberger’s illuminating article in The New York Times Magazine, the reasons for the stock market’s recent surge and apparent indifference to the coronavirus’ economic impacts are threefold.

One: The market is forward-looking and over 90 percent of the value of a stock seems to be dependent on projected earnings at least a year in the future. In other words, the market doesn’t really care all that much about the devastation befalling companies right now (or even the next quarter). It cares about what will happen a year or more in the future. And that outlook seems to be mostly positive, apparently not least because the current crisis is the result of an exogenous shock (and not something “homemade” like what we had thirteen years ago).

Two: The market’s behavior is significantly influenced by a handful of powerful companies such as Amazon, Apple, Google or Facebook. With those behemoths’ market positions already becoming more and more dominant prior to the crisis, share prices of those companies (and in consequence the entire market) have been factoring in that increasing dominance and have hence been going up -further fueled by the circumstance of “weaker” companies being disproportionately impacted or even annihilated by the effects of Covid-19. Furthermore, the small business community -the sector hardest hit by the crisis- is not represented in the major stock indexes. Simply (and tragically) put: The stock market won’t reflect or care about the disappearance of local delis and Mom and Pop coffee shops.

Three: With the U.S. Federal Reserve’s buying spree (corporate bonds, ETFs), all the cheap money being pumped into the markets and record low bond yields, investors basically have no alternative to investing their money in the stock market. And thus the market rises.

As explained in the article, there is another development that deserves specific mention: Promising companies have increasingly been bypassing public equity markets altogether, while private capital is booming. Indeed, the number of publicly traded companies in the U.S. has fallen by half since 1997. So with the rise of private capital and, in addition, the advent of high frequency-trading, Michael Steinberger is not wrong when he questions the entire point of the stock market and likens it to a “glorified casino”.

Featured post image: Photo by Patrick Weissenberger on Unsplash

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