For the past 8 months, this question has been the most often-asked question of the team at Wolf Group Capital Advisors (WGCA), a sister firm of The Wolf Group. We recently connected with Bob Len, WGCA Managing Director, to solicit his thoughts on the matter.
In this post, Bob shares a few key points that help to explain the seeming disconnect between stock market performance and the economic conditions of the past year.
To set the stage, recall that in the latter half of 2020, the stock market continued to show strong performance, all while the economy seemed to be struggling. All of this was happening during a pandemic that was predicted to worsen. Many believed that investors were just creating a different reality and would be punished for their unrealistic optimism at some point.
However, while the rapidity of the market recovery was surprising, there are rational explanations for why the markets moved the way they did.
- Markets tend to reflect what investors expect in 6 to 12 months. The first point to remember is that investors are looking to the future, so what is happening right at the current moment does not typically impact valuations. If we think back to mid-March 2020, we were all very concerned that the economy was shutting down. For those in the hospitality and travel sectors, their businesses did shut down. But for many in the services sectors, business, while impacted, did not shut down, and we pivoted to work from home. Our expectations in mid-March about our ability to do business in this new reality were very negative. But many of us found a way to continue to perform our jobs at near the same levels or with even higher productivity. So, the 35% market drop in March 2020 now is recognized as an over-reaction given how the economy continued to operate.
- The stock market is not necessarily representative of the economy. In the S&P 500, hospitality, including hotels and restaurants, is part of the Consumer Discretionary industry sector. Although this sector represents approximately 12% of the S&P index, hospitality is only a small part of that sector. Similarly, airlines are part of the Industrials sector, which is about 8% of the S&P. The airline industry is a small portion of the Industrials sector. So, the hardest hit industries in the pandemic only represent a very small part of the S&P 500 even though those two industries have a very large number of employees who were severely impacted by the pandemic.
- Stimulus efforts and the promise of a vaccine fueled investor optimism. There are any number of opinions as to why investors remained optimistic amid the economic uncertainties. One that has a lot of merit relates to the significant amount of stimulus injected into the economy by the US government and globally. As of the end of September 2020, the global stimulus was $12 trillion. With the second US stimulus package in December 2020 and other countries’ actions, the level is even higher now. Many investors believe we’ll have another stimulus package in the first half of 2021 as the economy recovers. Indeed, Congress is debating that package now. Stimulus funds tend to end up in equity and real estate market valuations, so it is no surprise that markets have reacted favorably to all of these funds. The impact down the road, when the debt matures and has to be refinanced, is a topic for a future article.
Another reason for investor optimism has been the big push for vaccines. As early as April 2020, many investors were optimistic that we would have a vaccine by the end of the year and were looking forward to a post-vaccine normalization of the economy.
- Finally, the rapid transition to a virtual business environment resulted in tech advances and a boom for the tech sector. The transition to a remote environment accelerated trends that were already in progress, such as the adoption of new technologies and virtual work environments. Plus, businesses have found ways to be more efficient and effective. Still, the adoption of technologies and the move to a more digital world are only in the early stages. Investors are optimistic about future growth related to these advances. In 2020, tech companies benefitted from the virtual business environment, and those companies make up a significant part of the S&P. In the past year, Microsoft, Amazon, and Apple accounted for half of the S&P return.
Although no one can definitively say which factors had the biggest impact on investors’ supporting higher market valuations, the four above help explain why markets potentially performed so well amid challenging and uncertain economic conditions. Now, with vaccine distribution underway, let’s hope that we can return to a more normalized environment, with continued growth, sometime this year.
Bob Len is the Managing Partner of Wolf Group Capital Advisors, which offers comprehensive wealth management solutions for global professionals and families. Bob is also the author of the weekly blog, Are We There Yet?, which he started during early April 2020, to chronicle thoughts on life and simple pleasures, as we navigate the daily tumult of the global pandemic, social and political unrest, and other contemporary challenges. You can check out prior editions of Are We There Yet? or subscribe directly on the Wolf Group Capital website.