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Is the stock market still related to the economy?

The US economy is in a deep crisis, but the stock markets carry on like before. Nervertheless, Caution is advised.

Stock market not related to the economy

Generally speaking, nobody can really time the market. If you have any doubts left about that fact, the coronavirus outbreak should put them to rest. Almost no one predicted the pandemic and absolutely no one knows where it is taking us. There is a wide range of opinions of what could happen, from life just returning to normal, to a completly new system that will take over. No one knows yet.

Unusual movements

Warren Buffett is an optimist. “Never bet against America,” the head of the investment company Berkshire Hathaway advised his shareholders at the virtual general meeting in early May. In the short term, however, the star investor was more worried than ever before and refrained from buying new shares in March, even though the prices were at their lowest for a long time at the peak of the Corona crisis.

The restraint seems – actually – understandable. After all, the virus is plunging the world’s largest economy into the worst crisis since the 1920s. In April, the unemployment rate shot up to almost 15 percent, the highest level since 1948. The Bank of England already warned of long-term damage in March.

But the stock markets have recovered unusually quickly. The bear market lasted only four weeks. Between February and March, the S&P 500 lost more than a third of its value. This absolutetly wrecked some nerves. But since then, things have mainly gone up. More than half of the losses have already been recovered. The S&P 500 is back to the level of last autumn 2019.

Only on Monday the share price increased by almost four percent, because, among other things, hopes for a vaccine triggered a celebratory mood among investors. The stock markets, they are decoupled from the economic developments. In April 20.5 million Americans lost their jobs – a new sad record. And the markets posted the best month in more than 30 years with a plus of 13.2 percent.

Movements in the stock market can have a profound economic impact on the economy and individual consumers. Notbaly the stock market crash of 1929 was a key factor in precipitating the great depression of the 1930s. Still, daily movements in the stock market has less impact on the economy than we would imagine.

Many companies fall behind

The central bank succeeded in stabilising the markets with unprecedented measures. For the first time in its history, it is also buying corporate bonds and will soon launch two programmes to buy municipal bonds and support lending to smaller businesses. This made the markets calm last month. But Fed Chairman Jerome Powell keeps stressing that financial support for the population must come not from the Fed, but from the Treasury Department.

But even the fiscal policy measures have so far mainly benefited companies with good relations to their banks. Many have fallen behind, which accelerates the problems in the economy. Smaller firms account for 44 percent of gross domestic product and more than half of all jobs. However, they have no access to the capital market and generally have fewer reserves. They are therefore much more affected by the crisis, which is not reflected in the indices.

The worst is yet to come. The amount of money being pumped into the markets by central banks may not be enough to get the engine of the economy running again. A number of companies are struggling with the heavy burden of debt. Several large retailers have applied for creditor protection in recent weeks. More would follow. This in turn would mean that people would have less money and thus not be able to stimulate consumption.

Moreover, some sectors have been hit much harder than others, and this too is not reflected in the indices. In the coming months, the focus could be on the question of who is among the winners and who among the losers. Investors should proceed with caution.

The big winners: Tech companies

There are two main reasons for this discrepancy. First, the tech giants from Silicon Valley. The five most valuable companies in the broad S&P 500 (Alphabet, Amazon, Apple, Facebook and Microsoft) now account for around 20 percent of the S&P 500, which weights companies by market capitalization. And three of the five, Apple, Microsoft and Amazon, are each worth more than a trillion dollars. Never before has there been such an imbalance.

The “Big Five” are still the darlings of investors. The tech companies are considered winners of the crisis and an investment for all weather conditions.

The dominance of tech companies is also one reason why markets have recovered even faster in the US than in Europe, where there are no comparable technology groups. Instead, there is a predominant concern about structurally weak banks and car companies (see also: US car market crash possible).

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