There is no doubt that the recovery of the stock market amidst the greatest worldwide economic catastrophe in living memory is obscene. More interestingly, is it deeply puzzling. Sure, the market is forward-looking. But the recovery is hardly in sight. Economic forecasts have never been as uncertain as they are as of writing. No one knows how long this pandemic is going to weigh on the economy. Or what the final bill will be. Michael Steinberger scratches his head over the puzzle on the pages of the New York Times Magazine. After flirting with the notion that stock buybacks were responsible for the fake rally before — that we have thoroughly debunked — he settles for a decoupling argument. The fortunes of the asset holders have decoupled from Main Street, he suggests.
Perhaps one lesson this crisis can reinforce is that we should stop thinking of the stock market as a barometer of national prosperity. Maybe it served that function in the past, but it doesn’t now. Instead, the market has become an emblem and engine of American inequality.
The stock market should never have been thought of as a barometer of national prosperity. What the stock market has always reflected, modulo valuation cycles, that is, modulo the risk appetite of market based intermediaries, is the fortunes of US firms. It does not track real median incomes, real wages, or any other measure of living standards of everyday people. Instead, when valuations are sound, aggregate stock market capitalization reflects the present value of future earnings of listed firms.
So why do present valuations not pass the laugh test? An intriguing hypothesis is that the pandemic has been good for the largest Silicon Valley oligopolists. In particular, people being grounded is clearly good for the likes of Amazon and Netflix. Does this hypothesis hold up under scrutiny? Has the rally really been driven by tech stocks?
Here we look at market capitalization by economic sector. It is true that tech stocks have recovered most of their lost market value (they’re at 93.9 percent of their previous peak). The recovery in health stocks has been even more robust (95.0 percent). That sounds reasonable given the nature of the catastrophe. But it may come as a shock to many that the recovery has been even more robust in — get this — the consumer discretionary sector (95.2 percent). Overall, the market is back up to 88.6 percent of its peak on Feb 19, 2020. Communications (93.7 percent) and consumer staples (88.8 percent) have also done well relative to the overall market. Meanwhile, energy, financials, industrials, utilities, real estate and materials have done worse; in that order.
The differential impact of the coronavirus shock has changed the relative market capitalization of the sectors. The numbers next to the sector titles are the relative share as of May 26, 2020.
We dig a bit more.
At peak market cap, on Feb 19, 2020, tech accounted for 24.8 percent of market value, healthcare for 13.8 percent, communications for 10.5 percent, and the two consumer sectors for 16.9 percent. As of yesterday, May 26, 2020, tech accounts for 26.3 percent, healthcare for 14.9 percent, communications for 11.1 percent, and the two consumer sectors for 17.7 percent.
Thus, tech’s share of market cap has increased by 1.5 percent. Meanwhile, that of the others surging sectors has increased by an aggregate of 2.5 percent: 1.1 for healthcare, 0.6 percent for communications, and 0.8 percent for the consumer sectors. So Big Tech is only part of the story.
Overall market capitalization is still down $3.2 trillion. The sectoral breakdown of this drawdown is displayed next. Astonishingly, the drawdown of tech stocks is behind only financials and industrials. In particular, it is larger than that in energy. These are aggregate effects, reflecting the sheer weight of technology stocks in aggregate stock market valuation.
Market valuations are back to where they were before the winter rally to where they had stabilized after the so-called Trump reflation trade. There was good reason to believe that market valuations were too high then. There is no doubt that they are too high now. And it is not simply tech stocks. The obscene rally extends well beyond technology.
What all this suggests is that, despite the weight of technology stocks, what we are observing is more than a purely local phenomena. That in turn suggests that the source of the obscene rally is the risk appetite of market-based intermediaries. What has driven market valuations back up to pre-winter rally levels is the collapse of risk premiums, which is in turn likely due to the Fed backstopping core funding markets. In other words, the obscene market valuations are a testament to the power of the monetary authorities.