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The COVID-19 pandemic wreaked havoc last year, turning the world upside down. While the world economy was probably hammered with one of the worst recessions since 1930s, the stock markets were going gaga.
Markets started to seem tone-deaf to the actual situation in the economy. Jokes were being circulated on how markets were “rallying on the prospect of good loss of jobs” or “rallying on the prospect of good natural disaster”.
The criticism of markets is not misplaced here – at least completely. Let us look in this piece why?
Stock markets move based on future estimates, at least that is what the bull lobby says. So, if markets are rallying today, they would be anticipating a good earning six months down the line. The general consensus in the markets across the world is that stock markets move on the basis of six-month forward earnings estimate.
In normal situations, this assertion is partially true. There has always been low positive correlation between the stock market movement and six-month forward earnings. In an ideal scenario, this should have either been perfect positive correlation or high positive correlation. The perfect positive correlation is out of question, and high positive correlation seems difficult, and conservatism is not the bulls’ cup of tea. But then the future is unknown. Who had known in October 2019 that by March 2020, a virus will erupt that will cripple the world economy? So, the largely ignored uncertainty factor has to be accounted for when investing.
But linking it to gross domestic product (GDP) numbers announced by any country is bit of an irrational comparison. To simply put, the GDP numbers have, over the years, become redundant – thanks to the irrational timing of putting this data out.
Despite global governments scrambling for more and more data on their citizens, GDP – a key metric to gauge well being in the country – is still backdated. This is irrespective economic and technological advancement by various countries. As of now, the GDP number are announced, at an average, two months after the end of the period. For example, the March-quarter numbers don’t come in before May-end.
Expecting markets to react to these is like reacting to a thing that happened two-months back. For that matter, PMI numbers, the employment numbers or retail sale numbers are more current in nature and should impact the markets more.
To sum it up, yes, the markets are irrational, but let us not have unrealistic expectation from markets till we set our house in order.
