indicatorMarkets

The stock market and the economy

By ATB Wealth 29 May 2020 4 min read

two people looking at charts

Now that much of the extreme volatility in the stock markets has subsided, the media headlines seem to be focused on the state of our economy. Unsettling words and phrases like recessions, unprecedented unemployment and negative oil prices are in almost every media broadcast.

It is important to add some context around the headlines and break down what is behind the headlines and what it means for investors. Let's review what is happening in the energy sector and why the stock markets seem to be shrugging off those unsettling economic headlines and continuing to drive gains.

 

What is currently going on with the energy sector?

Headlines that are near and dear to the hearts and livelihoods of most Albertans are anything related to energy. Unfortunately, the energy sector has been left fairly bruised amid the shutdown efforts related to COVID-19. Further to that, a clash of two petroleum exporting countries led to a price war.

Following a three-day meeting in early February, the Organization of the Petroleum Exporting Countries (OPEC) and other petroleum exporting countries decided not to enact production cuts. As a result of the decision by Saudi Arabia and Russia to increase the oil supply, a price war resulted and the oil price fell from $60 at the start of 2020 to $45 at the beginning of March, and then to only $20 per barrel by the end of March.

A dramatic drop in global oil demand followed as consumers began following distancing guidelines and spending time at home, and many businesses closed their doors.

Now, as parts of the global economy look to re-open, we are seeing some increase in oil prices. However, petroleum exporting countries, like Canada, are likely going to feel the pinch of the bruised energy sector. Until global demand picks up, we will likely continue to see volatility in the prices of crude oil as the world continues to have a lack of storage capacity.

 

Why does the stock market seem to be going up amid all the negative economic news?

Even though energy investors will most likely be dealing with volatility as the supply and demand dynamics of the energy sector are worked out over the coming weeks, months, or even years, we’re seeing some relief to the overall stock market.

Towards the end of March, stocks listed on major market indices began to experience positive growth which contrasts the drastic drops in value that were experienced earlier in the year. The month of April was a positive month for Canadian, US and International stocks as measured by their broad market indices in Canadian dollars.

There was growth across the S&P/TSX composite Index (18%), the S&P 500 (11.6%) and the EAFE (Europe, Australasia and Far East) Index (5.3%). The question then becomes, why is the stock market going up, when all of the headlines around our current economic situation still sound so dire?

 

The adjustment period for investors

Part of the reason for the increase is that investors have now had time to adjust to the bleak economic outlook and it is no longer driving emotional decisions. The sharp snap downwards in the stock market earlier in March was largely driven by investors’ emotions around the unknown repercussions of the global pandemic. When investors are faced with uncertainty, stock prices can be prone to dramatic swings as our human flight or fight emotions take over our decision making.

Now, as investors are becoming more familiar with hearing about the challenging energy sector, unemployment and closing business, the panic is subsiding and investors are looking to the future rather than sharply reacting to the present.

 

The stock market is not the economy

The other reason is that stocks are generally not a good reflection of our economy. At the most basic level, stocks are typically valued based on the future earnings and cash flows that an investor believes the company will be able to achieve. So, regardless of the scary news in the economy right now, analysts and investors are looking forward and trying to determine how a company will perform as the economy re-opens.

The government stimulus programs are a good news story for stocks as low interest rates encourage investors to spend money and invest. It also allows businesses to take advantage of relatively cheap debt that can help carry them through the rough patches.

In many ways, the stock market is like our favorite sports team, even if the star player is injured, fans still fill stadiums and cheer their team on in hopes of future wins once the star recovers. Right now, despite an “injured” economy, stocks are being lifted as investors believe in the future growth prospects of the companies that they are investing in.

 

How long is this going to last?

It is unclear how long this will last, but we are likely in a marathon, not a sprint. While much of the extreme volatility in our stock and bond markets have subsided, that doesn’t mean that we will not see it again this year. It would be wise for investors to anticipate future price movements in stocks and bonds as we work through the next year or so of life with COVID-19. The good news is that marathons (and marathon runners) do eventually finish, but the path ahead is long and can be exhausting.

Physical distancing rules are slowly being lifted, but we still have limits around how many people can gather together. Businesses that were closed are starting to reopen but they might not be fully staffed for some time. It will take time for our economy to fully re-open, but we do know that it eventually will.

 

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