Volatile graph with coronavirus overlay.

The Disconnect:

Pandemic vs. Markets

The pandemic has taken a massive human toll around the globe, and efforts to combat it in the U.S. resulted in the first recession and bear market in a decade. And yet, in recent months, stocks have recovered, with some indexes reaching or approaching new highs. How do we make sense of these conditions?

No Single Answer

Coronavirus directly affects the economy due to mitigation and social distancing efforts that shut down businesses and consumerism. But even as many family households and the economy face uncertainty, markets, particularly the U.S. stock market, have been rallying.

The disconnect between market performance and underlying economic strength might best be explained by viewing the current environment through four dimensions: the coronavirus, the markets, the economy and the government’s fiscal and monetary policies.   


The Coronavirus: Knowns and Unknowns

The “good” news is that the COVID-19 fatality rate is lower than originally feared, though still higher than the flu. The “bad” news is that the infection rate remains high. The U.S. has seen uneven testing availability and varying turnaround times, slowing effective responses via contact tracing and other policies.

Despite the impact on the economy, lockdowns have worked to slow the spread of the virus. The world is also gaining more clarity on which activities are high risk and which are not, potentially allowing for selective re-openings, or more nuanced social distancing policies.

This suggests that done right, certain sections of the economy may reopen and support job creation and consumer spending. But some sectors seem unlikely to recover without a reliable, global health care solution. For example, it is hard to see how long-distance travel can rebound to previous levels without an effective vaccine.

Next, there are still some “known unknowns.” It’s not clear how the virus will evolve in a school setting, as not all have resumed classes, and schools play a critical role to the broader economic reopening (consumer spending, parents returning to work, etc.).

The Markets: Accelerating Trends

The market recovery has been dramatic, despite the slowdown in economic growth and corporate earnings. In part, that’s because the pandemic and social distancing measures to combat it have accelerated or reinforced existing trends.

For example, online retail, streaming entertainment, cloud computing and video conferencing, among other segments, have seen rapid increases in adoption and usage amid the Great Lockdown. Many of these “COVID winners” have been high-growth companies concentrated in the technology sector. 

Many of these “COVID winners” have been high-growth companies concentrated in the technology sector. 

This has helped the tech-heavy NASDAQ Composite Index to record highs. The S&P 500® Index, too, has passed its February peak. The S&P’s tech sector enjoyed positive revenue growth and saw earnings fall just 2%, the best of all 11 sectors in this index.

But across the 500 companies that make up the S&P index, earnings were down 36% in the second quarter, while revenues declined 10%, indicating that the market as a whole may not be as strong as it appears.

The Government: Fiscal and Monetary Policy

The policy response has been much more robust this time than it was during the 2008 financial crisis. The Federal Reserve (Fed) and federal government both appear to have learned the lessons from past crises and have provided massive intervention. The Fed slashed interest rates to zero and continues to buy government and corporate bonds in its aim to support the market and lower bond yields.

Meanwhile, the federal government has passed $3 trillion in stimulus spending. Even though Congress is currently debating additional support, the fiscal and monetary policies have been enough to sustain the economy and put a floor under risk markets for now.

The Economy: The Shape of Recovery

Putting all the factors together, there are several potential recovery scenarios for what comes next, three of which we outline below. 

V-Shaped Scenario

A V-shaped recovery relies on the rapid development of a vaccine or an effective treatment, which could potentially lead to a potentially faster economic recovery. The easing of social distancing restrictions in the spring and summer saw the unemployment rate fall from nearly 15% in April to just above 10% in July. This seems to suggest that positive medical developments and less restrictive stay-at-home policies can lead to quicker improvement.

The connection between health and the economy depends also on people’s risk aversion. Confident in a treatment, people may feel comfortable with a higher risk of getting infected, which may increase economic activity in the short term. Such a resurgence of consumerism could lead to an economic recovery sooner rather than later.

However, bankruptcies, business closures and massive job losses present real obstacles to a rapid recovery. In addition, it seems likely some consumer behaviors may have changed. For example, airline travel, hotels and restaurants may not recover rapidly, even in the most rosy V-shaped scenario. Though there are many institutions working to develop a vaccine and optimism is high, a fully scaled and tested vaccine could still be six months or a year away. 

W-Shaped Scenario

The W-shaped scenario still suggests a recovery but also factors in a resurgence of the disease and likely economic consequences. So rather than a straight line down and straight line up like the V-shape, this scenario suggests an up-and-down or “double-dip” recovery.

This reflects the reality that as the economy reopened in the summer, we saw cases spike once more. The resurgence in the rate of infections led to more closures and social restrictions.

Despite these health concerns, a second, enforced economic shutdown is unlikely due to the current political and social environment. The number of coronavirus cases would have to reach a major new high to justify a renewed, broad government-ordered lockdown.

There’s a very real possibility that individuals may change their behavior going forward. Even if the economy stays open, people may be wary of going out and consuming at local businesses again, all contributing to a second economic slowdown—a W-shaped recovery.

U-Shaped Recovery

The U-shaped scenario is the most dire of the three, recognizing that firms cannot always recover quickly, so some significant portion of job losses could be permanent. Consider that the initial wave of cases created both a supply and demand shock. The demand shock has temporarily been alleviated by the massive fiscal and monetary policy response, and the supply shock would be alleviated by business re-openings.

Both are hard to mitigate fully. But supply has proven to be harder to treat than demand—there is no comparable government solution. The supply response has been driven by medical officials, who have prioritized the health care emergency in recommending a lockdown.

A few months of economic shutdown and one attempted reopening later, there is now a recalibration where authorities are again weighing the health care and economic balance trying to find a sustainable, long-term strategy. A U-shaped recovery scenario might mean that policy continues to keep the economy afloat until we have an effective treatment for the virus. But in this scenario, recovery would be much more gradual than in the other scenarios.  

Another factor that makes a full, rapid recovery difficult is disruption to the global supply chain. So much of the modern economy is based on frictionless global trade, but the pandemic and efforts to combat it have thrown up major challenges. As borders close and international tensions rise, there may potentially be an effort to relocate supply chains coming from China. But even as old connections break down, new connections are not immediately in place to produce new products.

Additionally, specific sectors, such as the "experience economy” (e.g., global tourism, conferences, etc.), could take longer to make a full comeback than many currently anticipate. Overall, a U-shaped recovery illustrates a slow, but eventual, full recovery that accounts for these significant hurdles to growth.

Policy’s Play Will Determine Everything After

Until now, policy has been filling the gap between the economy and the markets, working to mend the break caused by coronavirus. So far, it appears to be working, as the markets have returned to record highs.

The economic situation is less clear, however. How long can policy sustain the markets? And though the market seems to be headed for a V-shaped recovery, the resurgence of the virus and other potential stressors indicate a much more complicated trajectory.

The economic and market outcomes will likely depend on the coronavirus and policy response. In the meantime, it is reasonable to expect more market volatility until business, the government and the world at large have better clarity on what’s to come. 

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