COVID-19 is changing the way business is conducted, resulting in economic fallout, and stock market declines in many parts of the world. However, here in the U.S., while companies are closing, the stock market remains resilient in the middle of an economic crisis. Why does Wall Street appear to be disconnected from Main Street as businesses are permanently closing? The answer lies in the underlying economic fundamentals of our U.S. stock market system:
- The stock market looks ahead years, not months, to determine future valuations.
- Sectors are valued separately; the market values companies from many sectors to make up its full valuation.
- Market valuations do not reflect GDP or employment in the real economy.
As one sector is experiencing profitability, another is declining, resulting in layoffs, reduced profits, and stock market valuations. For example, the travel industry has been hit hard since the onset of COVID-19. Airline travel, hotel stays, and car rentals are down not only in the U.S. but worldwide. However, the pharmaceutical and technology sectors are experiencing significant growth. The U.S. has more technology companies than other parts of the world, signaling profitability in this sector.
“The more economic fundamentals and market outcomes diverge, the deeper the mystery becomes, until one considers possible explanations based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics. After all, stock-market movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.” –Robert J. Shiller. Understanding the Pandemic Stock Market, July 7, 2020, Project Syndicate.
Given that the stock market contains many sectors and companies, the specific mix of industries it represents has made it more resilient than the economy. Additionally, investor sentiment is pushing the valuations of some industries higher while other industry stocks are discounting. McKinsey and Company’s COVID tracker illustrates how the market valuation of sectors has changed from 2019 to October 12th, 2020, among these North American sectors:
- High Tech returns since 2019: + 55 %
- Automotive & Assembly returns since 2019: +48 %
- Logistics & Trading returns since 2019: +46 %
- Conglomerates returns since 2019: +32 %
- Oil & Gas returns since 2019: -44%
- Commercial Aerospace returns since 2019: -28%
- Air & Travel returns since 2019: -27%
- Banks returns since 2019: -23%
Globally, all sectors respond similarly, as production, economics and lifestyles change around the world. As industries continue to shift positively or negatively in their performance, human nature may be reactive to this short-term performance. As an investor, remember that time in the market beats timing the market, but strange times like this can create your portfolio opportunities.