Market at a disconnect with the economy

During points of inflection and turning points, it is common to see a disconnect between markets and the economy. This is because the market is looking 12-months ahead of the economy and current levels indicate where it thinks it will be in mid-2021.

This disconnect explains why markets are currently trading at 6000 points while the short-term economic outlook is for higher unemployment and negative impacts related to the winding up of the stimulus measures.

Prior to COVID-19, the ASX200 was trading at above 7000 points and fell to significantly below 5000 in February and March. The current market is effectively predicting that by mid-2021, while we aren’t going to be back to where we were, we are going to be a reasonable way back.

“Markets have now moved well ahead of where the real economy is,” explained Paul Taylor, Portfolio Manager, Fidelity Australian Equities Fund. “Markets look 12-months ahead and normally at turning point you do get this disconnect.”

Further, the uplift in markets has occurred at the same time as the second derivative change – we’d reached the maximum point of pain. The second derivative is the rate of change – a rapid acceleration or deceleration which marks a turning point.  And during this crisis it’s been measuring the rate of new cases – and the rate started to decrease.

“Markets turned at that point. Exactly to the day of the second derivative change, markets started to turn up.” In a U-shaped recovery, while the economy may still be in the bottom of the curve, the market is moving up the side of the U.

Taylor said up to now, governments around the world have been putting in place measures to reduce the health impact of the pandemic, however this has had a significant impact on markets, economies, and people’s lives.

Taylor said we are now entering a new phase of restarting the economy where we will see a pull back of government intervention, a reduction in restrictions and an opening up of business.

It is in this restarting of the economy where we will see how habits have changed such as work arrangements and the way people spend their time, as well as how economies have changed.

However, the forward-looking nature of markets do come with a warning. A lot can happen between now and mid-2021. “A lot can go wrong and there are setbacks that can change that.” Taylor said this crisis has been like a “giant social experiment” and a change in our habits will impact what the future operating environment looks like.