Why have stockmarkets risen when the news seems so dire? As confirmed by the UK government’s decision to extend the lockdown for a further three weeks, the coronavirus crisis is far from over. The virus continues to claim lives all around the globe, and measures designed to limit its spread continue to exert a powerful downward force on economic activity. Nonetheless, global stock markets are significantly higher than they were just three weeks ago.
Investors may be justified in asking whether this makes sense, and whether markets can possibly hold onto their recent gains. Though some have dissented, the majority of governments around the world have decided to prioritise containment of the virus above all other considerations. Closing non-essential workplaces and forcing citizens to stay at home has had a clear and significant impact on economic activity. In the US, some 22m people have filed for unemployment benefits in the past four weeks while the Chinese economy contracted 6.8% in the first three months of the year, the first decline in more than40 years. As signalled by the International Monetary Fund (IMF), many economies – including the US, Europe and the UK –may well suffer even sharper declines in economic activity.
Investors may be surprised to see that, against this bleak background, equity markets have nonetheless been making gains in recent weeks. The US stock market is some 25% higher in just three weeks, while the UK is up 14% and emerging markets have gained 16%. However, context is everything: as material as these gains have been, they have only partially reversed the losses accumulated earlier in March
Still, the question remains: why have stock markets have risen in the face of dire economic news? The answer lies in the forward-looking nature of financial markets. Equities (stocks and shares) entitle the owner to a share of the company’s profits. To assess the value of this share, investors look not just at this year’s profits, but at the company’s potential profits over a number of years to come. Signs that the crisis will prove temporary – for example, a return to more normal levels of economic activity in China and initial efforts to soften lockdown measures in parts of Europe – have reduced fears over the longer-term outlook for company profits, and stock markets have risen as a result.
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