Updated: Sep 10, 2020
By becoming the first American company to break the symbolic $2 trillion mark on August 19, Apple saw its market capitalization double in less than 6 months. For its part, Tesla and the video conference platform, Zoom, saw their share price respectively soaring by 500% and more than 400% since the beginning of the year. On top of that, the S&P 500 also reached historic highs exceeding 3580 points in early September. However, while the US equity market is witnessing a bullish V-shaped recovery, it seems quieter on the other side of the Atlantic with the STOXX600 still stagnating around 25% below its February level. And yet, macroeconomics indicators are still struggling to recover with an unprecedented 32,9% contraction in GDP in the second quarter, a range of bankruptcies, a plummeting dollar and not to mention that the unemployment rate increased from its lowest level in 50 years to its highest since the post-war period in less than 6 months.
So why is there such a gap between the real economy and the equity market, especially in the US ?
Figure 1: one year S&P500
Figure 2: One year STOXX 600
A Matter of Anticipation...
First of all, it is important to remember that financial markets don’t look at whether the real economy is doing well or bad but rather whether the situation will eventually get better or worse. In this case, there is a renewed confidence among investors and they are currently anticipating a net recovery in corporate profits within the next 12 months following the economies reopening as well as the growing hope that a COVID-19 vaccine will be available soon. The American companies Pfizer and Moderna or the British company AstraZeneca relentlessly working with Oxford researchers, have all entered in their phase 3 of trials where the vaccine effectiveness is tested and whose first results are already expected in September. Among others, the sudden and explosive post-confinement upturn in economic activity has notably been spurred by an increase in demand fueled by the unprecedented amounts of american savings accumulated throughout the confinement period which are now freed.
[...] financial markets don’t look at whether the real economy is doing well or bad but rather whether the situation will eventually get better or worse.
Subsequently, the Fed's monetary support measures have been much stronger and faster than those of the ECB, with greater quantitative easing and an injection of liquidity into the US economy of 8.5% of GDP, namely around 5 times more than in Europe. In order to bring inflation up to 2% and to foster consumption, US key rates have been brought to extremely low levels between 0.0% and 0.25% turning investors away from the no-longer-profitable bond market and urging them to rush towards equities to find lucrative opportunities. It is also interesting to note that the attraction of foreign investors for the American markets can be explained by the fall of the greenback as well as a lower change rate which makes it less costly for them to invest in companies listed in dollars.
Figure 3: U.S.A monthly inflation
Figure 4: FED Funds Rate
Finally, it goes without saying that the pandemic containment measures have fostered teleworking, e-commerce and the acceleration of digital transition. Additionally, the US stock market is 40% overweight by the Tech Giants, which, having significantly benefited from the health crisis, have propelled the US equity market to never-seen highs. This is notably demonstrated by looking at the NASDAQ, the index of the 100 largest technology companies, that has achieved the greatest performance and whose level is now remaining at +23% compared to February. In contrast, the European equity market is predominantly exposed to the Old Economy industries i.e. tourism, energy, automotive, retail or aeronautics that have suffered the most from the crisis, hence the performance gap between the two markets.
[...] the US stock market is 40% overweight by the Tech Giants [...]
Figure 4: one year NASDAQ evolution
Is The Trend Reversing ?
Nevertheless, the fall in the markets these last few days suggests that investors’ optimism may have been a bit too exaggerated and that the trend could undergo a reversal. The pandemic is still dwelling in the American and European minds while we are seeing a resurgence in many countries leading us to guess that the economy will still stall for a few more months. Furthermore, despite the significant early summer recovery, many people are still reluctant to go out to bars, restaurants or theaters leaving the services sector in a bad health state and scaring the markets at the same time. In addition to the sino-american tensions that could reappear soon, US election uncertainties are rising as national polls are showing a clear favor towards Democrats. However, while Joe Biden is at the head of a thoroughly fragmented party, Donald Trump enjoys an almost unanimous approval rating within the Republican party. The whole thing will now be for investors to keep a close look at the still undecided swing states.
Last but not least, while European countries have overall managed the sanitary crisis better than in the US, the announcements of national stimulus packages across Europe could contribute to support the recovery in the region. According to a Bloomberg analysis, forecasts of real corporate profits for 2021 will be higher in Europe than in the US and though European equities remained relatively steady this summer, they are properly valued and the STOXX600 will even be supposed to reach +36%.
Despite this, there still is a great deal of uncertainty about the development of the health and economic situation and the forthcoming weeks will be decisive in giving a clear overview of the US and European equity market as well as of the structural recovery from 2021 onwards.
Edouard Wauquier - Head of Corporate Finance