Stock Market Bent on Ignoring Economic Collapse Gets Haters

(Bloomberg) -- The famous Wall Street maxim that the stock market is not the economy is getting tested like never before.

Fueled by unprecedented stimulus and a slowing infection rate for the virus, risk assets have been staging a V-shaped recovery as traders front-run a rebound in a business cycle reeling from its biggest shock in decades.

After the best month for the S&P 500 in 33 years, stocks have deviated from growth data by the most on record, according to one metric. Ditto corporate bonds in Europe.

Equities that tend to win in the good times dubbed cyclicals have outperformed defensives even as Citigroup's U.S. economic surprise index plunged to the lowest since at least 2003.

Now, those economic warning signs have stopped the rally in its tracks. Following a barrage of terrible data, a gauge of global stocks is headed for the first three-day drop since the height of the sell-off.

It's a potential gut-check for investors in a market where no one can figure out with any confidence how to price the damage wrought by a once-in-a-century pathogen. One thing they do know: The market-versus-economy battle is in uncharted territory.

“Hope is playing a bigger role in asset valuations than I'm comfortable with,” said Abi Oladimeji, chief investment officer at Thomas Miller Investment in London. “Markets have priced in a lot that really remains highly certain and just a small variation, a small movement in those factors could trigger a disproportionate price response.”

Thomas Miller's portfolios have turned neutral on stocks from underweight, but are staying away from high-yield credit and higher-risk equities.

The S&P 500 is now up 26% from its March trough as slowing infection rates fuel hopes the global economy can begin to open up, while record monetary stimulus fuels a hunt for yield. The U.S. benchmark is now trading at 20 times the coming year's forecast earnings, near the highest since 2002.

Based on how bear markets in the last 150 years have tended to recover, Societe Generale SA calculated that the S&P 500 is likely to be 4% lower by the end of the year from Friday's close.

Risk assets have rallied on “the very important assumption that in 2021 the earnings will recover to the level that we saw before,” said Francesco Sandrini at Amundi SA, Europe's largest asset manager. “The temporariness of the current shock is quite a big assumption,” according to the head of multi-asset balanced, income and real-return strategies.

Yet in the telling of Citigroup Inc.'s credit strategist Matt King, more pain is coming in the form of a non-linear macro shock -- damage such as bankruptcies could rapidly accelerate as a lockdown of sorts continues.

Investors by contrast have been betting the market laggards have found a bottom. Small caps posted their best run since 2000 last week. U.S. value stocks -- which tend to be more cyclical -- at one point posted their sharpest gains versus growth peers in seven months.

To Jason Williams, a fund manager at Lazard Asset Management, all that underscores the risk that growth stocks will drag down the equity benchmarks they dominate, given that they're already near the most expensive versus value stocks since the dot-com bubble. With such valuations, it's likely their earnings will disappoint investors.

“As the economy continues to weaken, that mentality is going to be tested more and more and more because these growth stocks ultimately do have strong cyclical characteristics in them,” said Williams.

Last week offered a glimpse of this reality check when shares plunged after Amazon.com Inc. and Apple Inc. gave sobering remarks on the pandemic's earnings impact.

No wonder market sentiment is acutely febrile. The momentum-stock strategy, which buys the past year's top performers, is swinging the most since 2009 as traders rapidly rotate between defensives and riskier names.

All told, more whiplash is likely in a cross-asset trading landscape bereft of good economic news.

“Monetary policies are effective in boosting the price of financial assets -- I think that's undeniable,” said Amundi's Sandrini. “Where they are becoming increasingly less effective is in generating growth.”