With the global economy in the doldrums, the stock market’s booming performance seems to reflect a totally different reality, leaving many investors to wonder why.
The economic damage wrought by lockdowns and measures to control the spread of COVID-19 has been deep and sustained, leaving the global economy in a severe recession. Although most economists agree the global economy will bounce back in 2021, this outlook is being tempered daily in the face of the recent resurgence in global infection rates and continued signs of a softening in the economic recovery.
And yet, despite the pandemic-induced economic woes, global equity markets have largely soared, from the low reached on March 23. This performance has left many investors baffled as to the cause of this apparent disconnect between the performance of the economy and that of the markets.
Historically, the apparent disconnect between the markets and the economy is fairly normal. That’s because stock prices tend to reflect the outlook for the future earnings and prospects of a specific company. What the broader economy is doing at any given time can influence stock prices, but there’s not always a direct correlation. Looking at the current situation, while the overall economy is struggling, certain companies have actually prospered during the pandemic.
Another important factor is that the performance of an index – such as the S&P 500 – does not necessarily reflect the performance of all or even the majority of stocks that make up that index. If one or a few sectors of an index surge high enough, they can pull the overall index up with them, covering the poorer performance of the rest of the market.
And that’s exactly what’s happened: there’s been a massive surge in technology share prices. In fact if we strip away the performance of key technology company shares – specifically Facebook, Amazon, Apple, Netflix, Microsoft and Alphabet (the parent company of Google) – the S&P 500’s year-to-date return is actually negative.
Yet, this support for technology stocks even during the economic slowdown is reasonable. Their services and products are almost perfectly aligned with what their customers need in a socially distanced and locked-down world, including work-from-home support, telecommunications, online entertainment and education, web-based support, and point-and-click delivery services.
Adam Bosak is an Investment Advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.