The puzzling stock markets

COVID narratives and the stock markets

Robert Schiller identifies three separate phases of the US stock market performance:

• From the beginning of the coronavirus crisis, on January 30, to February 19 the S&P 500 rose by 3% – Although WHO had just declared a pandemic, lack of past experience with such event lead investors to believe that COVID was not going to have any effect on the economy;
• From February 20th until March 23rd the S&P 500 dropped by 34% – Investors’ beliefs were affected by a constellation of disturbing narratives coming out of China and Italy;
• Since then and to the present ,S&P 500 increased by 42% – Aggressive monetary and fiscal policies reminded investors of the actions taken to counter the 2008-09 Great Recession, which was followed by a gradual but ultimately huge increase in stock prices.

In all three phases of the COVID-19 stock market, the effects of genuine news are apparent. But price movements are not necessarily a prompt, logical response to it. In fact, they rarely are.

Understanding the Pandemic Stock Market
By: Robert J. Shiller – Yale University

The Fed’s backstop is a source of moral hazard

While we agree that the stabilization benefits currently exceed the moral hazard costs, it is difficult to escape the conclusion that, after having backstopped crisis markets twice in a dozen years, the Fed is now prepared to support virtually every part of the financial system. This leads us to fear that risk will be chronically underpriced, with investors pressuring the Fed to react strongly to even modest downward shocks.

Fed’s big stick lets it speak powerfully
By: Stephen G. Cecchetti, Kermit L. Schoenholtz – Brandeis University, New York University

Testing the relation between COVID infections and stock market performance

In this paper Brueckner and Vespignani use the daily growth rate of Dow Jones and daily new registered cases of Covid-19 infections in the US to estimate a vector autoregression model to characterize the dynamic relationship between Covid-19 infections and the market performance. They find a significant positive effect of Covid-19 infections on the performance of the stock market! One possible explanations the authors put forth: The stock market increases when output expands; but when output expands infections increase as well. Similar results were obtained for the Australian stock market as well.

Covid-19 Infections and the Performance of the Stock Market: An Empirical Analysis for Australia
Authors: Markus Brueckner, Joaquin Vespignani
From: Australian National University