Many have been wondering how the stock market is rising as unemployment soars and the global economy heads for a pandemic-triggered recession. A report from Richardson GMP examines sector weights, a growing service economy and the rise of the “quants” to offer more than the pat answer that “the stock market is not the economy.”
The S&P 500 is down only 1% so far this year, and the S&P/TSX composite is down 8%. “This is in the face of the grimmest economic backdrop since the great depression,” the report said, with the unemployment rates in both Canada and the U.S. around 12% and major economic contractions forecast for this year.
How is this possible? The report points to a few contributing factors.
First, the composition of indexes has changed dramatically in the last decade and is now much more technology-heavy. Tech stocks make up more than 25% of the S&P 500, but that doesn’t even include Facebook and Google-parent Alphabet, which were reclassified as communications services by Standard and Poor’s in 2018.
Tech stocks have been thriving during the pandemic, but the more “economically sensitive sectors” such as energy, materials, industrials and consumer discretionary no longer count as much in the S&P 500.
Second, advanced economies are becoming increasingly services-based, but most of the restaurants, salons and gyms that drive the economy aren’t publicly traded securities. Businesses with fewer than 500 employees account for 87% of employment, the report said, citing Statistics Canada data. But only 13 companies on the S&P/TSX Composite have fewer than 500 employees.
The “mom and pop” shops have been hardest hit by forced lockdowns while the technology companies thriving in the work-from-home economy tend to have small, highly skilled workforces, the report said.
Finally, the addition of quantitative investing strategies has influenced market prices. The report looks at the S&P 500 E-mini futures contract, which is popular among quants. The futures took a near-record short position starting in late February, which “added downward pressure on the market and likely accelerated the declines witnessed in February/March,” the report said.
This has reversed in recent weeks, which has probably helped the market thrive despite macro risks and negative news, and has contributed to the divergence from the broader economy.
“Add all this up and there are periods when the economy and stock market appear to be marching to two different drums,” the report said. “This can persist for months, quarters and even years — but it doesn’t last.”