Coronavirus recovery: why the market rally makes perfect sense – but is likely to end in tears

Name: Coronavirus backlash further fraying China’s ties to global economy
Uploaded: 2020-08-13T16:15:10.000Z
Duration: 5 min 2 s
Description: Coronavirus backlash further fraying China’s ties to global economy

Arguments that the rally in stocks is unjustified and built on weak foundations do not hold water, given the extraordinary measures taken around the world

The biggest risk is not that investors are complacent or irrational but, rather, the wave of global liquidity that is driving asset prices

3-MIN READ3-MIN

Signage outside the Nasdaq MarketSite in Times Square in New York on July 20. Contrary to some popular arguments, recent surges in stocks have been rational reactions to the extraordinary measures taken by governments and central banks in response to the Covid-19 pandemic. Photo: Bloomberg

Nicholas Spiro

Nicholas Spiro is a partner at Lauressa Advisory, a specialist London-based real estate and macroeconomic advisory firm.

Published: 12:15am, 14 Aug 2020Updated: 12:45am, 14 Aug 2020

On Wednesday, the benchmark S&P 500 equity index briefly surpassed its all-time high reached on February 19, just before the eruption of Covid-19 sent global markets into a tailspin. The dramatic recovery in stocks plays into the prevailing narrative that asset prices are dangerously detached from reality.

How is it possible, many financial commentators and investors ask, that the S&P 500 has gained 51 per cent since March 23 in the face of the most severe global recession since the Great Depression and a deadly pathogen that has infected a further 7 million people in the past month alone, many of them in America?

Even though stock markets are forward-looking and reflecting signs that economic activity – which in recent months has rebounded at a faster pace than many anticipated – will be much stronger in the second half of this year, the widely held view is that the rally is built on weak foundations and is unjustified.

This argument, though understandable given the devastation wrought by Covid-19, does not hold water when the extraordinary measures from the world’s leading central banks and governments are taken into account. Not only have policymakers acted more aggressively than during the 2008 financial crisis, they have provided investors with a firm pledge that policy will remain ultra-loose indefinitely.

The reaction in bond markets has been dramatic. The real 10-year US Treasury yield – which strips out expected changes in inflation from the nominal bond yield – has collapsed, falling from just over zero in late January to minus 1 per cent, a historic low. The last bastion of positive real yields and the world’s most actively traded government debt market has joined Japan and the euro zone in no longer offering investors a positive return.

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Coronavirus backlash further fraying China’s ties to global economy

The financial consequences of the tumble in real yields are profound. Practically every major move in markets in the past several months can be attributed to the real-terms loss on the highest-rated parts of America’s debt market. Negative real yields caused the US dollar to suffer its sharpest fall in a decade last month, drove up the price of gold to a near record high and are underpinning stock market valuations, powering the recovery in US equities.