Equities continued to bounce back in May from multi-year lows due in large part to optimism over business re-openings, declines in new infections, and progress in the development of a COVID-19 vaccine. The S&P 500 closed above 3,000 for the first time since early March, the Nasdaq ended the month less than 4% below its all-time high, and the Russell 2000 small-cap index, which was slow to join the market rally, ended up gaining more than 6% in May.
Yet many wonder how the stock market could drop almost 40% in the 5 weeks between mid-February and mid-March and then rebound to the extent it has while the news seems to be so grim. Are financial markets disconnected from the real economy? This is a great question...
In a market increasingly driven by computers that run on algorithms, and investors who at least in theory are always looking ahead, there is a tendency to gaze beyond the news of the moment. Stock prices today are anticipating where the economy will be in 6-9 months. Is it correct? Despite what some may claim, no one knows for sure.
While the current market still has some ground to make up, the trend in the markets recently has been positive. However, concerns remain that may lead to volatility in the coming weeks. Any sign that the economy won't heal as quickly or that the geopolitical issues and social protests could be more destabilizing, could hurt a market that has been boosted by hopes for a quick turnaround fueled by policy accommodation on a scale never attempted before.
Though the world is coping with a challenging situation, governments are working to provide fiscal and monetary stimulus to keep economies afloat. It seems likely to be a slow process of getting back to normal but there are reasons for optimism and that is the message I take from the market activity over the last several weeks.
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