How the Stock Market is Thriving Despite Global Economic Challenges
Despite the unprecedented global pandemic and its associated economic contraction, unemployment, and social unrest, the stock market continues to show remarkable resilience and strength. This article explores the key factors contributing to this phenomenon and explains why the stock market remains untethered from the broader economic realities.
The Discrepancy Between the Real Economy and the Stock Market
The global pandemic has led to a historic economic contraction, widespread job losses, and significant social unrest. Despite these economic challenges, the stock market has maintained a strong performance and even hit all-time highs. This unprecedented stability in the stock market presents an intriguing puzzle, which we will explore in this article.
1. Beating Out the Competition
The unprecedented fiscal and monetary stimulus measures have created an environment where stocks outperform other investment options. Interest rates have been lowered to near zero, and the US Federal Reserve has increased liquidity by ramping up its bond-buying program. This has more than doubled the liquidity injection compared to the period following the Lehman bankruptcy.
Key Points:
With low-interest rates, bonds become less attractive, while stocks become a more viable option. This trend is driven by rational investor behavior, as they seek the best returns.2. Supply and Demand Dynamics
In addition to fiscal and monetary stimulus, the dynamics of supply and demand play a significant role in the stock market's performance. The global financial system is awash with trillions of dollars, driving up competition for a finite number of investment options. The supply of stocks has decreased due to share buybacks by major companies over the past five to ten years, while the demand for stocks has increased.
Key Points:
Increased liquidity leads to higher demand for stocks. Reduced supply of stocks due to buybacks increases their value.3. High Weighting of Tech Stocks in the Index
The rise of Big Tech companies like Apple, Amazon, Google, Microsoft, and Facebook has significantly impacted the stock market. These companies make up a quarter of the SP 500 index, a significant portion of the overall market value. The performance of these tech giants has buoyed the broader market, even as many other stocks remain below their pre-pandemic levels.
Key Points:
The SP 500 is a market-capitalization-weighted index, giving tech stocks a higher weighting. Young people and retail investors have been drawn to the stock market through social media influences and entertainment investing.4. Increase in Retail Investors
The pandemic has spurred a new wave of retail investors. As traditional entertainments like sports betting and casino visits were restricted, people turned to the stock market for investment opportunities. Retail brokerages reported significant increases in new account openings, and social media influencers have played a crucial role in attracting young investors to platforms like Robinhood.
Key Points:
Retail investors account for a significant portion of market activity, particularly during lockdowns. These investors often trade in call options, which pushes the value of the SP 500 higher.In conclusion, the stock market's resilience can be attributed to a combination of fiscal and monetary measures, supply and demand dynamics, the disproportionate influence of tech stocks, and the growing presence of retail investors. While the broader economy faces significant challenges, the stock market's strength is a testament to the adaptability of financial markets and the rational behavior of investors in seeking safe and profitable returns.