Traders at the New York Stock Exchange earlier this year.
Photo: Michael Nagle/Zuma PressThe world is in a state of nearly unparalleled turmoil—except for financial markets, which seem blithely unaware. The S&P 500 was up a further 0.8% Tuesday, following a 0.4% gain Monday. That makes for a 10-day gain of nearly 5%.
That might seem illogical, but it isn’t. Markets care about one set of policy developments to the exclusion of everything else: namely, the fact that government rescue measures seem to be working, at least to the extent of avoiding worst case scenarios.
The U.S. is being rocked by protests of a scale not seen for half a century and Washington and Beijing are facing off over Hong Kong, all amid a raging pandemic. But even the riskiest corners of markets are ticking away from distressed levels. The spread between safe U.S. Treasury bonds and U.S. high-yield bonds, excluding energy, metals and mining, is down to around 5.5 percentage points. It reached a high of 9.7 percentage points in late March.
Markets have often shrugged off geopolitical stress—North Korean missile strikes, clashes in the Middle East—but the gap between what’s happening in the world and in the market seems extreme even by those standards. Analysts note that a year’s earnings doesn’t matter much to a company’s valuation under a discounted cash flow model. As long as earnings bounce back next year—or even the year after—a likely lower-for-longer interest rate is enough to justify gravity-defying stock markets.
So it matters a great deal, to the exclusion of almost everything else, that the rebound is indeed relatively quick. If the first stage of the rebound was about the realization that central banks would take extraordinary measures to prevent market distress and widespread defaults, the second hinges on the ability of policy makers to engineer a rapid rebound within a year or so, largely with fiscal policy.
Data released late last week offered ballast for optimists: Despite a wholesale collapse in production, personal incomes rose by 10.5% between March and April, as stimulus checks hit mailboxes.
The fiscal backdrop has been generally encouraging elsewhere too: the European Union’s pooling of financial resources for a €750 billion ($840 billion) recovery plan outstripped expectations. Japan also announced a 117 trillion yen ($1.077 trillion) recovery plan, of which more than a quarter will be direct spending.
But the next developments bear watching. U.S. partisan conflict over what stimulus comes next has risen. How much the next round of spending will pare back generous jobless benefits which end in July, and how spending will be used to encourage a return to something more closely resembling normalcy, has yet to be seen.
What happens with stimulus policies and incomes isn’t the only thing that matters, of course. But as long as the spread of the coronavirus is seen as under control in advanced economies, and a vaccine is expected to arrive eventually, it will be quite close to the only thing that matters for markets.
Write to Mike Bird at Mike.Bird@wsj.com
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