By Andy Wang
As the Dow and S&P 500 continue to rally into new highs since a downturn in March, COVID-19 cases surged to more than 4.7 million in the United States on Sunday, according to data aggregated by Stanford Medicine.
Is this a logical trend?
“Since their lows in March, stocks have quickly recovered as many analysts were drawing parallels between the COVID crisis and the holiday season in December,” wrote economics professor Monika Piazzezi in an email to The Daily. “The lockdown would be like the vacation that people take between Thanksgiving and New Year: nobody works, firms lower their production level, and in January everybody returns to work and production resumes at its full level.”
According to Piazzezi, chief economists of banks like Goldman Sachs have expected a V-shaped recession, a sharp drop in gross domestic product from which we would recover immediately.
“Some of the early signs, such as spending on durable goods in May, were confirming this [V-shaped] outlook,” Piazzesi wrote. “There was news about the faster than usual development of a vaccine and about new treatments for COVID-19. These medical advances would support a V-shaped recession.”
The Federal Reserve said on Wednesday that it will maintain interest rates at around 0% and vowed to use all means to combat the recession and stabilize the economy. In addition, the Central Bank has increased its holdings of bonds, which enhances the liquidity of financial markets.
“These factors — expectations of a quick economic recovery and monetary policy — underlie the recovery in stocks,” Piazzesi wrote.
While these factors bolster the rebound of stock prices, Piazzesi added, there is volatility. Indications of a prolonged U- or W-shaped recession, with multiple waves of the coronavirus, have led to declines in stock values.
“Stock values tend to be lower in recessions but because they are forward-looking,” Piazzesi wrote. “They tend to recover much faster than the economy. At the same time, there were famous examples of stock market crashes, like the 1987 Black Monday, that were not associated with anything bad happening in the macroeconomy. Such crashes are associated with a sudden drop in risk appetite by investors.”
Management and accounting professor Charles Lee said he sees two possibilities behind the current market situation.
“It looks like the market is suggesting a full recovery 47% increase earnings in approximately a year or thereabouts,” Lee said. “Now, if you disagree with that, then you’d say prices are too high. But if you don’t disagree with that, then there [stock prices] are within the ballpark. Given these really low rates, you cannot rule out the fact that the prices are reasonable.”
Lee said he is deeply concerned by the Feds’ zero interest rate policy. Zero-interest rates, he said, can cause people to do things they would not otherwise do.
“It is not economically healthy in the long run because growth needs to come from the increased productivity value increased by economic activity, but interest rates being lower than it is economically sensible is essentially like an exchange between today’s spending and tomorrow’s spending,” Lee said. “When interest rates are low, what we spend today is what we normally would have spent in the future. Now that stimulates the economy today, but not in the future. Especially when we as a society are going more into debt.”
According to Lee, this low-interest rate could cause an unsustainable level of economic activity. Despite this concern, he said that the firmness of current stock prices does not indicate a bubble similar to previous recessions such as The Great Depression and the 2008 subprime mortgage crisis.
“At this point, I think [stock prices] are high ,” Lee said. “But it depends on whether or not corporate earnings are able to recover in the dramatic fashion that the pricing is currently implying.”
Management and science engineering associate professor Edison Tse, on the other hand, said that the current firmness the market has been showing could possibly indicate a bubble.
“People spend too much money, just floating money,” Tse said. “The Fed is pouring money into (the economy). You’re not gonna buy bonds so the interest rate is not good. It is a dangerous sign to me.”
Tech stocks, Tse said, are currently firing up while smaller companies are taking the hit. Overall, the pandemic will change the ways businesses operate.
“The virus may change a lot of the habits of [businesses and people],” Tse said. “Businesses have to rethink what we can or cannot do. Because of that, I think it would take some time for people and [the] economy to recover.”
Tse added that the performance of the stock market does not truly reflect the day to day lives of people. Whereas, in the past, this correlation was very much prevalent: the market reflected the confidence of the people.
According to Lee, companies that have strong moats, a competitive advantage, from stay-at-home economies such as FANG (Facebook, Amazon, Netflix, Alphabet) will continue to drive the market.
In addition to 0% interest rates, Lee said he is concerned by the effect of the coronavirus recession on the wealth gap — there are distinctions between Main Street (the average person/business) and Wall Street (high net worth investors and global corporations).
“Wall Street largely reflects the opportunities for capital deployment: it is reflecting the average dollar or marginal dollar going forward, which looks a lot more optimistic than mainstream where we’re talking about the average person’s household balance sheet,” Lee said. “It is a wedge that’s lasted 1520 years. The economy has done really well and investors have done really well. But the average household has not kept up.”
Lee said he has shifted his investments more into real estate, which is more of a hybrid investment, part bond part stock.
“In terms of the overall balance, I would encourage most people not to try to do too much because people are just not good at timing,” Lee said. “One of the most remarkable and consistent results in behavioral finance is that people are terrible at market timing.”
As for the Stanford community, Piazessi said, stock valuations directly affect the endowment.
“A large portion of the endowment is invested in stocks and if they drop in value, the university will spend less,” Piazessi said. “This will affect our students, staff and faculty.
Contact Andy Wang at andy612.wang ‘at’ gmail.com.