Boston - With equity prices recovering amid persistently negative —at times historically so — macroeconomic indicators, the disconnect has been puzzling. Or perhaps, the rebound has simply served as a reminder that equity markets are a discounting mechanism. If so, we might be able to view the change in equity prices as a time-tested leading gauge of what could await.
The market has staged a historic comeback, although the S&P 500 Index is still down 7% for the year through May 26, and the average stock continues to lag the broad market by another 7%.
Disconnecting from economic data
A summary of recent macro data demonstrates the obvious disconnect between equity market and economic performance. The S&P 500 Index's ascent, albeit from trough levels, has taken place in spite of the worst unemployment since the Great Recession, the biggest drop in the Purchasing Managers' Index (PMI) since the Global Financial Crisis, dismal corporate management confidence, plunging Leading Economic Indicators (LEI) and a declining earnings trend.
Analysis from Ned Davis Research (NDR) reminds us of two important, somewhat overlooked perspectives: The S&P 500 has risen at a faster pace when the unemployment rate has been high and when earnings expectations have been low.
Over long historical periods since 1948 and 1985, respectively, the S&P 500 has posted a gain around 13% per year when unemployment has exceeded 6% and expected earnings growth has been below 3%. We have observed that much of this has been driven by market's persistent price reset prior to reported economic data.
We suspect that while a vaccine for COVID-19 — a key "all-green" signal — remains elusive, such dispersion in economic data, equity valuations and performance will likely continue.
Bottom line: In our view, the unevenness of the recovery serves to highlight the upper hand of structural winners — stocks of companies enabling and accelerating the digital adoption of goods and services across consumer, communications, health care and technology sectors. We believe that as long as equity volatility persists, so will the advantage gained by these structural winners.