Is the stock market rally misleading?

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

Website: www.forextime.com

It must be kept in mind that the world economy is still expected to contract by 3% in 2020

  

Who would have thought that nearly six months after the coronavirus menace paralysed the global economy and battered financial markets, the S&P 500 would rise to record highs like a phoenix from the ashes?

After slumping to a pandemic low back on March 23, the S&P 500 has surged over 50% making the bear market that started in February the benchmark’s indexes shortest in history! Traditionally, rising stock markets are good news and create a sense of confidence over the direction of the economy. However, global economic conditions over the past few months have been nothing to celebrate about with the negative impacts of COVID-19 creating a crisis for the real economy. While the sharp recovery in stocks over the past few months may massage the egos of equity bulls, it may also revive fears about the widening disconnect between Wall Street and Main street.

It must be kept in mind that the world economy is still expected to contract by 3% in 2020 according to the International Monetary Fund (IMF) while the United States continues to tussle with rising COVID-19 cases among many other negative themes. In Q2, the largest economy in the world contracted by a record 32.9% with millions of out-of-work Americans still suffering after a staggering 56.2 million Americans sought unemployment aid in just 21 weeks. It is the same story outside the States, with Europe, the United Kingdom, other developed and emerging markets nursing deep wounds from lockdown restrictions. At best, the outlook for 2020 remains clouded by uncertainty.

To be fair, a sense of optimism over Russia approving the world’s first coronavirus vaccine has supported global risk sentiment, but this certainly is not enough to keep equity markets elevated.

Global equity bulls seem to be deriving strength from unprecedented central bank action and handsome fiscal packages unleashed by governments across the world. Trillions of Dollars in fiscal and monetary stimulus has boosted financial markets, sending yield-seeking investors rushing towards equities despite the growing list negative themes weighing on global sentiment. To add to this, the concentration of gains witnessed in Big Technology companies has fuelled concerns about the sustainability of the rally, especially when factoring tensions between the United States and China.

The S&P 500 is now up almost 4.5% on a year-to-date basis with stocks potential powering higher to fresh records if the next round of US fiscal support measures can be rolled out sooner rather than later. However, the key question is whether equity bulls have become dangerously addicted and heavily dependent on liquidity support to keep the party going? Time will tell.

Any opinions expressed in this article are the author’s own

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