The Disconnect Between the Stock Market and the Economy

Bloomberg columnist John Authors has called it “the most hated global stock rally in history,” viewed more skeptically than even the decade-long rise that followed the Financial Crisis. But here we are, up nearly 40% in a period that included the biggest 50-day rally on record.

At first, this dramatic upward move in equities appeared to be non-intuitive, taking place in the face of a lot of historically bad data. But then came the May jobs numbers. Economists were expecting a drop of 7.5 million. Instead, jobs were up 2.5 million. Unemployment was predicted to hit 19% from 14.7%; it fell to 13.3%. Head shaking data.

The stock market shot up on the news and yields on the 10-year treasury jumped more than 13%, to .93%. It was a remarkable turn of events. The point we consistently make here is not that any given rally (or selloff) is, or isn’t, rational; markets often go their own way, disconnected from the economy for periods of time. Rather, it’s that the timing of these things is impossible to predict. Two months ago, who expected an upturn of this magnitude?  More reasonably, an investor might have looked around, seen all that was going wrong, and moved to cash.

There is an extra layer of uncertainty to the present circumstances, as evidenced by the failure of all concerned to see the surge in employment numbers: we’re in uncharted territory. The pandemic, the reaction of global central banks, the massive fiscal and monetary stimulus pouring into the economy are all unprecedented. Traditional forecasting tools – which tend to extrapolate on current trends – have never been particularly good at capturing inflection points. Combine that with the fact that most gains (and losses) in the equity markets occur over relatively brief periods, and you can see why timing the market doesn’t usually work. (For a recent example, consider the nearly 6% drop in the S&P 500 on June 11, when sentiment suddenly turned negative.)

What has been demonstrated to work is diversification, and a long-term focus. There will forever be debates over growth vs. value, small cap vs. large, and the benefits of exposure to asset classes like commodities, real estate and international stocks. In our view, they all have their place in a diversified portfolio. The bigger issue is almost always investor behavior in the face of extreme circumstances and high levels of volatility. The global pandemic brought both.

This further strengthens our argument for the role of liquid alternatives. A fund like the IQ Hedge Multi-Strategy Tracker (QAI) provides broad asset class exposure through the sub-strategies in which it invests (Macro, Long/Short, Fixed Income Arbitrage, and Emerging Markets, for example), offering built-in diversification and exposure to non-correlated asset classes. This can help dampen volatility during periods of market stress, while providing continued exposure to both stocks and bonds.

For nearly two months, the markets have been implying a pretty sharp economic recovery, flying, it must be said, in the face of a lot of “expert” opinion and generally glum news reports. Now evidence continues to build that growth is resuming. A few weeks don’t make a trend, but the magnitude of the shift is encouraging. Cities are opening up and people are heading back to work. While there’s no guarantee this will continue – and setbacks are always possible, in the economy and with the coronavirus – optimism is starting to return. But the markets have been ahead of the curve. Hated or not, this rally has again demonstrated how hard it is for even experts to anticipate an inflection point, while reaffirming the value of a long-term plan.

Related: May Brought Both Hope and Heartbreak