The S&P 500 closed on a new record-breaking high this week, leading some to conclude that the US market has completely recovered its losses from coronavirus – but Fidelity International’s Tom Stevenson thinks this isn’t the case.
Earlier this week, the blue-chip index closed on 3,390 points, surpassing its previous all-time high set back on 19 February by four points.
S&P 500 vs other indices YTD
Source: FE Analytics
This February high was the peak before the US fell into the fastest, and shortest, bear market in history, dropping from 3,386 points to 2,237.4 points on 23 March, falling by 20 per cent as the coronavirus pandemic spread.
Prior to coronavirus, the US market had led the post-financial crisis bull run and, with the S&P 500 surpassing that level, it could have many people thinking that the US market has completely recovered from the impact of coronavirus.
But this stands in direct contrast to the shambled state of the US economy and society as a whole.
The country is still battling to get coronavirus under control. There have been just over 5.5 million cases of the virus, with the number of new cases not yet reaching a steady decline.
At the same time, US unemployment is currently at 10.2 per cent, according to the latest available data from the US Bureau of Labor Statistics, with another 1.1 million people starting new unemployment claims in the past week.
And all of this is occurring during a socially contentious US presidential election, the outcome for which is set to have a major impact on the market.
The realities in the US economy appear worlds apart from the US market.
Stevenson, investment director at Fidelity International, said: “For many people, this will be incomprehensible.
“First, the medical crisis is far from over - indeed in some parts of the world it is flaring up again. Second, the economic crisis it has triggered is barely getting into its stride. Here in the UK, the end of the government’s furlough scheme in a couple of months’ time threatens the worst unemployment since the 1980s.
“This hardly looks like a supportive backdrop for the resumption of one of the longest-ever bull markets. Investors’ optimism is surely misplaced.”
Scratching the surface of the US market’s major rally since March and Stevenson highlighted three reasons why the S&P 500’s new all-time high doesn’t equal a full market recovery.
“As ever, in investment, the numbers tell a story but only a partial one,” he said.
“We are used to noting that the UK stock market is a poor guide to the health of the British economy. But this is also true in America.”
First, looking at how the S&P 500 companies have actually performed individually from 23 March to date, it’s clear that not all of them have made up its coronavirus losses but the few that have have done so enough to drag up the entire index’s returns.
“While it is the case that the S&P 500 has regained all of the ground lost since the market bottomed in late March, this is only true at the aggregate level,” Stevenson explained.
“Around 60 per cent of the shares in that index remain below their previous high and the average price is 7 per cent down from that high-water mark.
“By definition that means that some shares have done exceptionally well since March, and we know that this is the case. Technology stocks, which are perceived to be the principal winners from the pandemic, have risen well above their previous highs.”
In the decade prior to the coronavirus the S&P 500 was a major benefactor of the rally in technology growth stocks, especially since it held some of the biggest global names. Microsoft, Amazon, Apple, Alphabet and Facebook have all seen their share prices go up majorly in the past few months.
Jeff Bezos officially become the richest man in the world, with his fortune now at $138bn, after Amazon became the biggest player in e-commerce, a theme which has thrived during the global lockdown.
It’s peer Apple became the first US tech company to reach a $2trn market cap this week, taking only two years to double its valuation.
All five of these companies have thrived during coronavirus and combined have accounted for 25 per cent of the total rise in the index from the March bottom.
“The five companies represent a fifth of the value of the index by themselves,” Stevenson said.
So, one reason for the S&P 500’s dramatic rise to pre-pandemic levels isn’t down to the overall health of the index, but the performance of its already dominant growth tech stocks giants pulling it up.
“It is not really an index of the US stock market but one high-performing corner of it,” Stevenson said.
A second explanation is “the different time-horizons of the economy and the stock market”.
The economy is more near-term focused area whereas the market is more forward future looking, Stevenson explained.
“While economists are concerned with what will happen over the next few months or possibly a handful of years, investors should really be concerned with the earnings potential of companies far out into the infinite future,” he explained.
“Clearly the profits that a company will make in the next five years carry a bigger weight (and are more easily forecast) than those it will make in 20 years’ time. But all of those future profits need to be taken into account when deciding on the right value of a share today.”
This means that any near-term declines made up for by a quick recovery don’t have a major impact on the long-term value of a share.
“If this is the market’s expectation, then it follows that in the short term there might be an apparent disconnect between the immediate outlook and investors’ assessment of the correct price for the share,” Stevenson added.
A final reason is the “extraordinary stimulus”, provided by governments and central banks since February.
“It is no coincidence that the US stock market hit its low point this year on the day that the Federal Reserve announced its intention to purchase corporate bonds in an unprecedented bid to support financial markets by reducing the cost of borrowing for companies and reducing the likelihood that they would be dragged under by the pandemic,” Stevenson said.
By suppressing bond yields with major amounts of stimulus it meant that shares, although expensive when compared to a company’s profits, look reasonably priced when compared to the alternatives. “Indeed, shares are no more expensive than the long-run average when placed up against bonds,” he said.