Posted on Tuesday September 08, 2020

Making sense of the stock market rebound

When the pandemic hit last March, the stock market took a historic tumble. So how do we explain its rise again amid a global recession with a second wave of COVID nosing up on the horizon?

Up, down, up again: We explain why the stock market bounced back so fast and what gives it is staying power, despite the instability and uncertainty in the financial world.

Why is the stock market always ahead of the curve?

The stock market is like a financial barometer: It tells us what the weather will be BEFORE we see the sun or the storm. It’s the first thing to react to major events, and it’s sensitive to both macro data, like the unemployment rate and government announcements, and other more irrational factors. Some shares take off or take a dive based on investors’ emotions or due to speculation. In this way the stock market’s volatility can be indicative of future global economic movements. But it can’t exactly tell the future.

The human behaviour behind the financial markets

Smart, experienced investors don’t panic when the market drops. They know this is the time to buy stocks at a good price. They accept short-term losses because they’re looking for a return over the long haul. Beginner investors, on the other hand, often don’t have a long-term plan and are more emotional and skittish about their investments. They may buy at the height of the market on the wave of public enthusiasm, then sell out of fear when the market starts to plummet.

Few areas can elicit such an emotional response as money. Meb Faber, cofounder of Cambria Investment Management, offers this ironic explanation in the journal Conseiller: “Investing is the only business where everyone runs out of the store when things go on sale and rush back when prices go back up.” 

Investors react to COVID-19

The numbers speak for themselves. In the first week of March, in the face of this unprecedented health crisis, investors shed billions of dollars of investments in mutual funds and exchange-traded funds (ETF) ($13.6 billion in US assets for just that week according to Reuters, a global press agency). A good portion of this money is still sitting as liquid assets in the hands of private individuals and fund managers, waiting to be reinvested.

Calming the beast with measures from banks and governments

Distancing, slowdowns, shutdowns and layoffs—with the financial tidal wave brought on by the crisis, central banks and governments took extraordinary measures to counteract the effects of the lockdown on the economy. Federal programs such as the Canada Emergency Response Benefit (CERB), cheques signed by Donald Trump sent to our American neighbours and similar efforts to bolster the social safety net in Europe, Japan and elsewhere reassured investors and stabilized the markets, limiting their volatility for a time.

Such measures are necessary to avoid losing significant ground and to keep the recession from turning into a depression. We seem to have escaped the worst, but as the relief efforts and financial supports are gradually rolled back, that could put the stock market back on the rollercoaster again. In the current climate we need to be prepared to deal with a certain fragility and uncertainty in the market.

Bank on the sectors that are involved in the recovery

When you look at the big picture, the economy is never all black or white. Some players might be on the bench, but others jump in to keep the game going. In March that meant that hard-hit sectors like energy and industry gave way to healthcare, tech, telecoms and consumer products. These sectors have been able to make money during the crisis and now make up more than 52% of the market capitalization in the US, according to Olivier Passet in La Tribune.

The same trend has been observed in Europe, where healthcare, technology and telecoms are coming out on top and energy and industry are trailing far behind.

The funhouse mirror of the stock market

Like a funhouse mirror, the stock market tends to overweight the sectors that have benefited from the crisis. The result is a picture of the market that’s not a precise reflection of the economy. Instead it shows us how certain sectors that are heavily represented in the indexes are performing.

The real economy does not necessarily affect the stock market directly. There are gains to be made because some sectors are doing quite well but other sectors with less spectacular performance are not as directly represented in the stock market.

Is it better to keep your investments in the stock market when interest rates are so low?

With interest rates at rock bottom and governments borrowing hand over fist, you can expect the rates on products like government bonds to stay close to zero, which makes those investments less attractive since their yield will be negligible or nothing after inflation.

On the other hand, the stock market gives you better long-term returns, especially if your investment strategy is effective and you follow it to a T, as we heard from Daniel Bergeron, Director of Wealth Management at UNI, in a recent interview. Following the plan you created with your advisor or planner is still the best way to achieve your long-term goals. Make an appointment with your specialist for help managing your investments during the crisis.