The market rally in the face of social turmoil, an explainer

When you see police shooting rubber bullets into a group of protestors in Washington and New York, or if you see the aftermath of looting and destruction in multiple cities across the US, you could be forgiven for thinking that the stock market would be in turmoil. Surely investors will be reducing risk as they digest what mass protests and the prospect of the military on American streets means for the economy and the social and civil fabric of the world’s largest economy? Nope, as America has been plunged into social chaos and political disarray global stocks have surged and the Vix, Wall Street’s fear gauge, has fallen to its lowest level since March. 

The investment community is not turning a blind eye to events in the US, some investors may well be taking part in the protests, particularly in New York. The lack of volatility in global stock markets does not mean that investors do not have empathy towards the deep issues that are bubbling to the surface in America right now, instead it is a good reminder that stock markets and corporate valuations are not a reflection of reality. So, why are stock markets rallying right now, and is this sustainable? 

·     The Fed: it has launched lending and credit facility programmes worth $2.3 trillion to help households and businesses during the Covid-19 pandemic. This is an unprecedented amount of support and is much larger than the support offered during the 2008-09 financial crisis. This comes on top of emergency interest rate cuts to ensure that money keeps flowing through the economy. This situation is the ideal environment for stock markets, they LOVE liquidity and there has never been more liquidity in the global financial system. There has also been ample support from the ECB, BOJ and BOE, along with plenty of cash support from global governments around the world. The global economic system is awash with cash right now and that is fuelling this rally and the massive improvement in global risk appetite. At some stage the Fed and other central banks will have to start increasing interest rates again and clawing back some of the money that they have printed to support the global economy, however, that time is not now or in the foreseeable future, hence why the stock market is rallying and acting like the coronavirus pandemic has stopped being a global threat. 

·     Economic data:while many economists have ditched their expectations for a “V”-shaped economic recovery, some dire economic analysts’ expectations for data in May have been wide of the mark. As an example, economic analysts had expected ADP private sector payroll numbers in the US for May to show a decline of 9 million private sector jobs, however, the actual number was far less with a drop of 2.76 million last month. This is still a large number of jobs to lose, but at less than a third of what was expected, we could call this an economic win. It may suggest that the US jobs market could bounce back faster than expected and could be less exposed to coronavirus than previously thought as more people can work from home, or some industries actually benefit from the pandemic such as online delivery firms, online grocery deliveries and some software firms such as Zoom. As economies around the world start to open up, there is hope that the worst of the job losses in the US could be behind us. Elsewhere, the economic data has also picked up in line with the loosening of lockdown restrictions around the world. In the UK and Europe PMI readings for the manufacturing and services sectors beat expectations, in the US the manufacturing and non-manufacturing ISM surveys also surpassed expectations. The US services sector saw a decent recovery in employment and in new orders for May. This has fuelled a near 3% rally in the FTSE 100 and the German Dax, along with a decent open for the US indices. 

·     Time is a great healer:This is also one of the reasons why the market is not reacting to the turmoil going on in US society right now. Partly it’s because the market thinks that police brutality and the Black Lives Matter movement do not have a direct link to stock market valuations. Partly it’s because they expect the protests to die down in the coming days. This does not mean that individual investors are lacking in empathy or don’t feel the pain felt by some Americans right now, instead it means that there is a belief that the issues can be dealt with in a timely manner in the political arena. The political arena is extremely complex, which is why politics often don’t drive financial markets. However, this is also a risky strategy. If the protests continue until the Presidential election in November, or if they escalate, then we believe that the stock market will reassess their economic impact and it could weigh on stock prices. This could be one reason why European markets are outperforming their US counterparts so far this week. 

·     Laggards are catching up:A Fed-fuelled stock market recovery rally along with signs that the spread of coronavirus is slowing are powerful drivers of global stocks right now. The wave of euphoria is also lifting up some of the companies that were hardest hit by the pandemic. The FTSE 100 is one of the strongest performers on Wednesday, and its best performers include Rolls Royce up 10%, EasyJet up 6%, IAG up 9% and Whitbread up nearly 5%. The biggest losers include defensive companies such as Ocado, Reckitt Benckiser Group and Tesco. This is another sign that the stock market rally is strong. As an example, IAG (British Airways parent), fell from 643p in February, down to less than 160p in mid-May. This stock is in the early stages of its recovery, and has made up 25% of its recent loss, and is currently trading around 273p. If the virus’ potency continues to decline, economies continue to open up and the Fed keeps the money taps running, then we would expect IAG to continue to rally. 

To conclude, there are some who are looking for the stock market recovery to falter based on the following: the pandemic isn’t over, there could be a second wave of infections, protests could lead to serious political fallout in the US and the global economy remains weak. We would argue that these are concerns to consider, however, the market view at the current time is that they are low risk. While the Fed and other central banks continue to keep cheap money flowing through the global financial system, while economic data keeps surprising to the upside and if the protests in the US fade out then the stock market rally could continue. The two biggest risks to the stock market rally, in our view, is a second wave of Covid-19 infections spreading across the world and prolonged and increasingly violent protests in the US.  Until these events happen then we believe that the rally appears safe for now.