Video: Why do markets rise when economies slump?

In the midst of this pandemic, markets and the economy have moved in the opposite direction to each other. So what on earth is going on?

Forward looking

Markets are forward-looking. A share price captures all future earnings of a company. Any news that impacts those earnings expectations can move markets before it actually shows up in financial statements. This is exactly what has happened.

Most of the bad news was already priced in when markets crashed in the first quarter of 2020, as investors anticipated the economic slump ahead of the release of any official economic data.

For the same reason, share prices also capture the subsequent recovery, which is why we have seen markets rebound recently.

Huge stimulus packages

The catalyst for the rebound was the huge stimulus package that central banks and governments unleashed. This has eased fears of a credit crisis and supported asset prices.

It is also worth highlighting that the stock market is a poor representation of the economy. For example, the largest US technology companies contribute 20% to the total US stock market value, even though their revenues are only 4% of US GDP. This has also widened the disconnect between markets and the economy.

Looking ahead, investors shouldn’t rule out the possibility of a further market correction if the economy remains shut for longer than expected, or worse if a second wave of infections occurs.