Why have share prices been rising while economies have been falling off a cliff?

What could explain this remarkable bounce back in shares? And if the economy is going into the worst slump since the Second World War, asks Ben Chu, can it possibly last?

The Dow Jones Index had its best week since 1938 in late March, the same week in which an unprecedented 3.3 million Americans applied for unemployment insurance (Getty/iStock)

Western stock markets sank at a record rate in February and March as the seriousness of the Covid-19 pandemic finally dawned on investors and speculators.

American equities fell faster even than during the Wall Street Crash of 1929.

Yet there has been a surprising turnaround since then.

Since 23 March, prices are up more than 20 per cent in the US, putting them in a technical “bull market”.

The FTSE 100 in the UK also briefly went into bull market territory earlier this week.

What’s made these share price rises even more remarkable is that they have coincided with some almost apocalyptic unemployment and growth projections.

The Dow Jones Index had its best week since 1938 in late March, the same week in which an unprecedented 3.3 million Americans applied for unemployment insurance.

So what could explain this remarkable bounce back in shares? And if the economy is going into the worst slump since the Second World War, can it possibly last?

Central banks have ridden to the rescue

Major central banks in the US, Europe and the UK have committed to buy back hundreds of billions of dollars, euros and pounds of financial assets in recent weeks.

The US Federal Reserve has essentially committed to unlimited purchases and has massively widened the scope of the type of financial assets it will buy as well.

Some see that perceived US state backstop for shares as the primary driver of the stock market recovery.

“When you remove near-term bankruptcy risk from every publicly held company, regardless of credit rating or near-term financial condition, asset prices should rise,” says Nick Colas of DataTrek Research.

“Markets know that no matter how bad cash flow might be there is a Fed loan backstop waiting in the wings if needed.”

Even if it doesn’t mean a direct bailout, this perceived sense of support is important, says Oliver Marciot of asset manager Unigestion.

“As long as unlimited support persists, downside risks to holding risky assets will prove limited,” he says.

Coronavirus cures are on the horizon

Markets have tended to rise on positive reports of drugs trials and vaccine headlines.

Gilead Sciences, which is working on the potential Covid-19 treatment Remdesivir, is one of the top performing US stocks this year.

And some analysts think medical news has been important in lifting the spirits of investors more broadly.

“I would say the vast majority of the move off the low [of share prices] is related to healthcare developments. Most people believe that we’re going to get some sort of vaccine,” says Dennis DeBusschere of advisory firm Evercore ISI.

Forward-looking markets

The theory of stock markets says that they look ahead, not at the present.

Some think the reason for the share rally is that market participants are now expecting a rapid recovery.

“With investors gaining confidence, a V-shaped post-pandemic economic revival is now being priced in,” says Nigel Green of the deVere Group financial consultancy.

“Investor exuberance is contagious. As the markets move steadily higher, unfazed by the recent poor economic data from the peak of the pandemic, it can be expected that the uptick will further sharpen due to that powerful investor sentiment: fear of missing out.”

Will it last?

It’s impossible to say with any confidence. The bulls might be right, especially if we get a stronger economic recovery than many fear.

Yet some think shares could easily collapse again. It wouldn’t be historically unprecedented.

Share prices rose a few months after the Wall Street Crash, only to plummet again, with the market pain lasting for the next three years.

“This looks like a bear market rally, similar to that in 1929-30 with an additional 30 to 40 per cent drop in stocks to come as the deep global recession stretches into 2021,” says veteran analyst Gary Shilling.