At the March lows, stocks were discounting the kind of economic collapse we’re currently in the midst of; but the subsequent rally is less about economic optimism, and more about Fed-provided liquidity.
The stock market’s V-shaped rebound is unlikely to be matched by a V-shaped economic rebound.
Longer-term, we will likely see the U.S. economy shift from consumption-driven to investment-driven.
The speed with which the U.S. stock market went from all-time highs to deep bear market territory broke all historical records. Then the rally that ensued was one of the fastest “new bull markets” ever in history; allowing the month of April to be the strongest since early-1987. Given the weaker start to the current month, expect to hear louder chants of “sell in May and go away.”
The warp speed nature of the past few months is unprecedented in many ways—both in terms of the economy and the stock market. The speed of the stock market’s collapse was directly tied to the collapse now underway in the economy. But what of the speed with which stocks retraced more than 60% of the collapse? In a phrase (coined by my first boss, the late-great Marty Zweig), “don’t fight the Fed.”
The Federal Reserve’s balance sheet has ballooned to about $6.7 trillion (see first chart below); as part of an unprecedented (there’s that word again) set of actions to save the economy during the COVID-19 crisis. Adding the relief packages from Congress and the Treasury Department, the combination of monetary and fiscal stimulus has reached more than 26% of expected 2020 GDP (see second chart below).
Fed’s Balance Sheet Goes Parabolic
Source: Charles Schwab, Bloomberg, as of 4/29/2020.
Fiscal Plus Monetary Stimulus
Source: Charles Schwab, as of 4/29/2020. *Real GDP based on CBO (Congressional Budget Office) economic projections for 2020. Phase 1 provides funding for vaccine, therapeutic, and diagnostic development; Phase 2 provides grants for unemployment insurance, a 6.2% increase in Federal Medical Assistance Percentage (FMAP) for Medicaid, and refundable tax credits for paid medical and sick leave; Phase 3 establishes the Paycheck Protection Program (PPP); Phase 3.5 provides enhancements for the PPP and additional health care enhancements.
It appears the “Fed put” was alive and well in April—a period during which the spread between how stocks were performing and how the economy was performing hit a record. As you can see in the chart below, the z-scores (representing standard deviations from the mean) for the S&P 500 and Citi’s U.S. Economic Surprise Index have moved dramatically in opposite directions.
Extreme Divergence Between Stocks and Economy
Source: Charles Schwab, Bloomberg, as of 4/30/2020. A Z-score measures a value's relationship to the mean (average) of a group of values, measured in terms of standard deviations from the mean.