Why the stock market seems to be living its own life in the middle of crisis

This text has been written a couple months ago, but the speculations in the article seem still viable.

The fact is that this ongoing coronavirus pandemic is going to hit the economies of most countries and the world economy hard. Some way this should have an effect on stock prices since a lot of companies are going to lose sales in the declining economy.

I think there are multiple reasons behind the stock rally that has been happening in the past month. I will bring them up for you and tell a bit about the reasoning behind the theories.

Governments around the world are announcing stimulus packages to keep on the consumption and keep businesses standing. Many businesses at least in the service industry are suffering since the Covid-19 pandemic has forced them to close their doors and cut off most or all of their income streams. The stimulus packages are strengthening the faith of the public in the economy and it is that way strengthening the markets.

Two biggest central banks in the world, the FED and the ECB have announced wast securities purchase programs. Central banks are buying government and corporate bonds from the aftermarket. This has been argued to keep the financial markets working and securing that governments and corporations are still able to get funding from the markets. Because of these enormous purchase programs, great amounts of new money is entering the economy which in a way keeps the economy rolling. If the financial markets froze and governments and companies wouldn’t be able to get funding, it would create a deep downturn in the stock market since many listed companies are running on borrowed money.

Inflation and inflation rate are important concepts in our modern monetary systems. The central bank purchase programs are creating great amounts of new money to the economy. This builds up inflationary pressure. However, the inflationary pressure hasn’t been concretized as an increase of the inflation rate in the economy, at least yet. This has to do with the deflationary pressure that is created by the decline in consumption. Without purchase programs, the inflation rate could be smaller or even turn deflationary. Inflationary and deflationary pressures neatly cancel each other out and the inflation rate stays stable in the closeness of the normal 2% rate.

I recently watched Interview of Ray Dalio the founder and Co-Chairman of Bridgewater Associates by Bloomberg Invest Talks. And he pointed out that the monetary inflation created by central banks doesn’t right now result as a price inflation (increase of prices od goods against the currency). However, the value of the currency is declining even it doesn’t show as traditional inflation, because of the deflationary pressure. Monetary inflation still has an impact on stock prices and the price of gold. You can watch the interview below.

Markets often overreact in dramatic events. It is possible that the bottom of the stock market in March was too low taking into consideration that the pandemic hadn’t hurt businesses' ability to create money at least yet. I think this is true at least in case of some stocks but I can’t say if it has that big of an impact on the whole market. I think this has the smallest impact compared to the others brought up earlier.

In conclusion, the stimulus packages and the securities purchase programs have a specific effect on the economy, on the other hand, a declining economy has its own typical effects to itself. How the market and the actions taken play together create the events that have an effect on our financial lives.

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