Explaining The Disconnect Between The Economy and The Stock Market

On Friday, April 17, 2020, DJIA rose 2.99% to 24,242.49 points, S&P 500 - by 2.68% to 2874.56 points, Nasdaq - by 1.38%, to 8650.14 points The June S&P 500 futures are trading at 2863.12 points (-0.25%) at the time of writing.US futures fell on Monday morning amid a sharp drop in oil prices. Investors continue to worry about falling demand due to the pandemic. May futures for WTI crude oil fell 15.49% to $ 15.44 / bbl. The major stock indices in the Asia-Pacific region (APR) are mostly growing after the People's Bank of China (PBOC) cut the base interest rate on loans for the year from 4.05% to 3.85%. The interest rate on loans for five years or more has been reduced from 4.75% to 4.65%.US Treasury Secretary Stephen Mnuchin said he was discussing with the Democrats a new financial aid package, of which $ 300 billion is expected to be directed to small and medium-sized businesses, $ 75 billion to hospitals, and $ 25 billion to national COVID-19 testing programs.New York State Governor Andrew Cuomo announced that the state, along with the declining number of hospitalizations, has decreased the number of new infections.On Friday, US President Donald Trump announced that the authorities will allocate $ 19 billion to support agriculture.ECB President Christine Lagarde announced the imminent recession in the euro area. The currency bloc economy faced a sharp drop in GDP and a rapid deterioration in the labor market, she said.US markets rallied on Friday after a report released Gilead Sciences' Remdesivir is effective in treating coronavirus. Markets have also reacted positively to the relatively imminent resumption of economic activity in the country.The number of people infected with coronavirus in the world continues to grow - at the moment it exceeds 2.4 million people, the number of deaths has exceeded 165 thousand.There will be little economic statistics in the coming week, the main influence on the markets will be provided by the financial statements of IT companies and the oil and gas sector. At the moment, 9% of US companies have reported, the drop in their net profit was the highest since 3Q2009. On Friday, the Russian Central Bank will hold a key rate meeting; we expect a 25 bp cut.IBM, Infosys and China Mobile will report their financial results on Monday.We expect markets to rally on Monday, driven by Mnuchin's announcement of a new economic aid package and a declining number of infections in New York State.May futures for WTI crude oil fell 15.49% on expiration of May futures and growing fears that raw materials will soon have nowhere to store due to record low demand. In Texas, some companies buy oil at $ 2 / bbl. This may lead to the fact that producers will soon have to pay extra to buyers for the sale of raw materials.It is not the first year that the global stock market is overheated. Today, the capitalization of the stock market exceeds the size of the real economy, which, according to experts interviewed by the Prime Agency, is extremely rare in history. The IT sector looks especially overheated. The situation looks alarming, but extreme shocks in the financial markets should not be expected, at least until the Fed embarks on a rate hike cycle.BURST SOON OR HAS NOT YET Inflated?Talk about the overheating of the American (and global) markets has been going on for a very long time, in fact, they began after the recovery after the 2008 crash, says Dmitry Alexandrov, Deputy General Director, Head of Analytical Research at Univer Capital.Indeed, during this time economies grew more slowly than indices, and national debt in major currency zones reached record historical values.Last year, the situation worsened even more: the fall in GDP and growth in government borrowings are accompanied by new highs in stock indices.Financial markets are updating their highs in stocks and lows in yield in bonds, and questions about the presence of a bubble in certain asset classes arise more and more often, continues AndreyRusetsky, asset manager of BCS World of Investments.Currently, the US stock market looks overheated. The so-called Buffett indicator - the ratio of the capitalization of American companies to GDP - is at highs and is 160% of GDP (the previous peak of 130% was observed in 2001). In Russia, for example, this level does not exceed 50% of GDP.Another popular indicator - the price / earnings multiple (the main parameter for assessing stock markets) is approaching the levels of the 2001 dot-com bubble and is 22 annual profits.However, in these indicators, market capitalization is measured in terms of profits or the size of the economy, and the pandemic has led to their sharp decline. Higher multiples reflect investors' expectations of economic recovery and corporate profits, that is, the market has already incorporated these indicators into the price.The Russian stock market is trading at a 40-50% discount to emerging and developed markets and an 8% dividend yield - it's cheap. The dividend yield is higher than the Russian one is observed only in one market - Pakistan, Rusetsky notes.RATIONAL BUBBLEThere are many financial indicators that indicate that financial markets may be overheated, says Valery Yemelyanov, an analyst at Freedom Finance. For example, the ratio of the stock market size to GDP.«Now the capitalization of the stock market exceeds the size of the real economy, which is rare in history. Also, the assessments of companies in the IT segment and the biotechnology industry look quite strange and unusual. In terms of profit-to-capitalization, some of them are several times more expensive than the market as a whole,» - he points out.Thus, the payback period for the largest technology companies - Amazon, Paypal, Netflix, Nvidia - is approaching a hundred years. Despite the fact that the maximum norm is 20-25 years. For small and medium-sized companies, the payback period can be up to several millennia. There are dozens of such examples, which «again is an anomaly.»«If you look at the P / E of individual companies, the indicators can really shock,» says financial advisor Anna Kharchenko. «It will take you 1,676 years to recoup your investment in Tesla shares, but it’s hardly correct to say that the entire market is becoming a bubble. Representatives of cyclical industries - energy, transport, finance are still far from overvalued levels. »According to Emelyanov, to explain everything that happens, the concept of a «rational bubble» appeared. The bottom line is that investors are significantly overpaying for shares, seeing how central banks are pumping the economy with cheap money. Meanwhile, as soon as there are signs that the easing policy is going to be phased out, investors will return to standard estimates.A bubble is considered a situation when the price of assets is significantly higher than the real value, explains Kharchenko. The gradual growth process is like blowing up a soap bubble. In this case, they say that the market is in a bullish trend. A rapid fall is when the bubble bursts - in such a situation, the bears make money on the decline.«The main problem is to determine the peak point, but we can only know it after the fact, » she says.ON THE BOND MARKETAn interesting situation arises in investment grade bonds denominated in US dollars, Rusetsky draws attention. The yield went below 2%, that is, below inflation.Real rates on US government bonds and investment grade corporate issues are negative. This leads to the formation of high levels of debt and negative real returns for investors (mainly pension funds and other conservative clients).As the global economy recovers, many commodities have hit their highs, deviating far from cost levels. For example, oil futures curves have entered backwardation, that is, they show a decline in prices in future periods.However, the discrepancy makes sense for several reasons, according to market experts. Namely, the stock market is not an economy. Equity investors are looking beyond current conditions to what they think will happen in the future and they are currently looking at it with optimism, experts sayNior index analyst at S&P Dow Jones Indexes spoke about the difference between the economy and the stock market. «The market says, «We know where we are today, but where are we going tomorrow? » - said Silverblatt - In that case, tomorrow is 2021.Thus, the stock market as a link in the financial system, on the one hand, experiences all the negative phenomena in the country's economy, and on the other hand, it is the most important indicator of macroeconomic processes.REFERENCESCastells M. Information Age: Economy, Society and Culture. M .: GU HSE, 2000.Kafiev Y. 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