The front cover of this week’s Economist highlighted the growing gulf between the stock market and the real economy. Over the past two months, many of us have watched US equity’s rip-your-face-off rally with significant disbelief and nontrivial FOMO. Personally, I’m still waiting for another correction, but I’ll admit maybe my mental markets model is operating on a stale pre-COVID paradigm. Let’s enumerate and commentate:

• The economic numbers are bad. Unemployment, projected GDP, consumer sentiment, corporate earnings, you name it. The only silver lining is that without a precedent for these numbers, markets don’t know how far to fall. The aggregate market has tacitly agreed enough is enough and priced in the bad economic news, thereby knocking us into a new market regime. The new regime has held incredibly sticky despite a surfeit of bad news – indicating that unless there’s another regime change, the market is relatively inelastic to further bad news. Investors are becoming accustomed to and increasing rewarded by the knee jerk response “don’t care, already priced in.” It’s taken a few weeks, but I think investor sentiment is starting to tilt towards treating the comically bad numbers more seriously.
• After-glow of monetary and fiscal stimulus nukes. Respect to the Federal Reserve and Congress – the magnitude and speed of government intervention saved the day. After its initial QE boosters lasted mere hours, the Fed revealed a step-by-step unexpected arsenal. This begs the question what other hidden tools the Fed has in the event of markets double dipping. The market seems to believe that the Fed will do whatever is necessary and takes comfort in not knowing the size nor shape of the Fed’s magic bag. Today the Fed indicated what isn’t in the bag (negative rates) and called upon more fiscal stimulus. The current consensus is that while already astronomical, more fiscal stimulus is on the way. These two pronged stimulus interventions have strengthened investor sentiment and rocketed markets back up. You could argue that the stimulus juice has been too heavy handed, but that’s an unproductive argument without knowing the counterfactual. Even if you believe that the buoyed sentiment is artificial, the stimulus juice isn’t going to run out anytime soon – you can’t wait that long for a regime correction. Whatever you do, don’t fight the Fed.
• Economic reopenings and COVID vaccines. Broad-market sentiment seems to be primarily driven by optimistic economic reopening schedules and anticipation of an early COVID vaccine. I think the market is overly focused on headline reopening dates and hasn’t accounted for a multi-stage reopening nor a subdued spending recovery. Reopening is going to be piecemeal and economic activity driving regions reopened last. Even if a full reopening occurs smoothly, consumer spending will be subdued because we’ll be in a real recession, not because the stores aren’t open. The market has only priced in the current economic shutdown and is hyper-sensitive to news regarding a second COVID wave in the fall. Markets are generally optimistic towards antibody screening and vaccine progress, but I’d reserve a healthy scepticism in how economically relevant they’ll be. The current regime is so forward looking that such ephemeral hopes are driving massive price movement.
• Low Rates + FOMO = Attractive stocks. A significant part of the recent growth is driven by the low rate environment making US equity look more attractive. Investors seem to be falling into a FOMO trap – expressing a rational disbelief of the new market regime, but unable to sit out on the sidelines.
• US equity >>> international equity. With the exception of China (Chinese central bank shenanigans), US equity is significantly outperforming international equity despite having a much weaker COVID prognosis. Part of this can be chalked up to the intrepid spirit of US capitalism, which fueled much of the US equity outperformance of the past decade (the other part is explained by US equity’s heavy tech bias). A more cynical belief is that US equity optimism is dragging up international equity by the bootstraps. Even if the outperformance is temporarily justified, US companies won’t be immune to international economic activity going kaput.
• Election risk. Too early to tell.