Why are markets disconnected from the data?

It has been a surprisingly positive fortnight for equity markets. The Dow posted its best two-week rally in 82 years, closing Friday’s trade above 24,000. Meanwhile, the Nasdaq flipped back into positive territory for the year last week and the FTSE 100 kept its head above the respectable 5800 mark. Volatility in the US stock market also calmed to its lowest level in over a month, in another sign of trader optimism.

The markets were gripped by risk-on sentiment ahead of the weekend on hopes of a coronavirus vaccination. This came on the back of an anecdotal report which said that a Chicago hospital trialling Gilead’s Remdesivir drug, appeared to improve patients’ COVID-19 respiratory and fever symptoms, sending shares in the biopharmaceutical company up by almost 10% in the session. On top of vaccine hopes, a number of European countries with flattening curves, including Spain, Italy and Germany started to ease some lockdown restrictions.

Also providing support to the markets since the lows in March has been the wave of fiscal and monetary stimulus measures from governments and central banks around the world to stem the damage from the viral outbreak. This included a pledge from the Federal Reserve (Fed), to effectively provide unlimited lending to the US economy. This week, China cut its own benchmark lending rate, with economists at ING predicting more stimulus ahead from the world’s second largest economy.

However, while the markets are in a relatively cheery mood, the economic data tells a different story. Thursday’s weekly initial jobless claims data revealed that for the prior week, another 5.2 million Americans registered for unemployment benefits, bringing the four-week total up to a staggering 22 million people who have lost their jobs as a result of the coronavirus. The current labour market picture is in stark contrast to where it was at prior to COVID-19, when the US economy had enjoyed more than 100 months in a row of employment increases. China’s latest gross domestic product (GDP) figures released on Friday revealed that its economy shrank by 6.8% in the first quarter (Q1), its first contraction since official figures began nearly three decades ago.

Why are equities so disconnected from the economic backdrop?

One explanation could be that no one really knows how bad things are going to get for the global economy and whether we should be bracing for a shorter-term recession or a deeper prolonged depression. According to Bank of America, the divergence of global growth forecasts has vastly increased, suggesting that uncertainty about the economic outlook is at the highest level in history.

Otherwise perhaps there has been too much faith from the markets in central banks and governments to handle the crisis. Or that the gains have been driven by a few individual stocks like Amazon, Netflix and Gilead, rather than a healthy market rally, displaying strong market breadth.

Can the divergence last?

While the stock market is remaining resilient for now, there is a growing number of investors who are reviving their short calls against the market. At least that’s according to a report from the Wall Street Journal, citing analysis from S3 Partners, which said that bets against the SPDR S&P 500 Trust, rose to $68.1 billion last week, the highest level since January 2016.

While the divergence between the markets are the economy remains intact for now, it is surely only a matter of time before both will be singing from the same hymn sheet once again.