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“The overall stock market can do relatively well even when employment and GDP are severely depressed“– Paul Ebeling
The US stock market remains strong during the COVID-19 chaos because of 3 Key factors that reflect certain truths about valuations, the market’s composition, and investors’ expectations. These 3 factors are very real.
The stock market takes a long-term perspective.
Today investors realize that even if it takes 2 to 3 yrs to restore a normal level of GDP and profits, the China virus long-term effect on share prices will not be that high.
Let’s assume that for the next 2 yrs, corporate profits will be 50% lower than they otherwise would have been and will then return to their pre-chaos marks and growth rates. The discount the impact of lower short-term profits and cash flows, the present value of the stock market declines by less than 10%.
The stock market does not set a value for the market as a whole.
The market values individual companies from many different sectors, and these companies add up to the whole. Especially now, performance within/across sectors. Companies in Oil & Gas, banking, and travel, for instance, have been challenged in here, and their performance is down. Within the retail sector, grocery stores have generally fared well but department stores have not. Some companies in pharmaceuticals and in technology, media, and telecommunications are doing better now than they were at the beginning of the year. This in part because the introduction of new products and services affects them more than the health of the broader economy does. As a result, the stock market’s aggregate value is and remains resilient.
This dynamic is even more pronounced now that the telecom sector carries greater weight than ever before: its share of the Top 1,000 companies has increased from about 14% at the end of Y 1995 to about 35% in September 2020.
Alphabet, Amazon, Apple, Facebook, and Microsoft collectively account for 21% of the market’s value, up 16% at the beginning of Y 2020. Without these 5 mega cap companies, the value of the Y 2020 market would have increased by 3 Vs 9%. And without the telecom sector as a whole, there would have been Zero growth.
The market value of listed US companies doesn’t reflect employment or GDP levels in the real economy.
Companies from high-growth sectors that have done well during the chaos now heavily weight the US stock market. By contrast, many sectors that have done worse account for a smaller share of the market and often have few listed companies.
Many apparel retailers and department stores, for example, were already under pressure even before the pandemic, and their market values were low. The current collapse of these companies’ share prices does not have much impact on market aggregates.
Many of the construction and professional-services firms, gyms, hairdressers, hospitals, restaurants, and other service businesses that generate lots of jobs and contribute materially to GDP are not even listed.
“The overall stock market can do relatively well even when employment and GDP are severely depressed”
Similar dynamics are at play in Europe and Asia. In Europe, for instance, telecom companies account for only 10% of the market, Vs 35% in the United States.
Have a healthy weekend, Keep the Faith!
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