Investors in Asia kicked off the week in an upbeat mood, with most major equity indices trading in positive territory. The upside momentum seems to be a continuation from Friday’s Wall Street session which saw the S&P 500 adding 1.7% and the Nasdaq Composite erasing all losses for the year following a 37.5% rally from its March trough.
Charts of US major indices are already reflecting a V-shaped recovery with the Nasdaq Composite only 7.9% short of its record high and the S&P 500 15.8% below its peak.
For many investors, the divergence between Wall Street and Main Street does not make a lot of sense especially as it seems to be widening. No figures in history match Friday’s non-farm payrolls report, which showed a record 20.5 million jobs losses for April and unemployment reaching 14.7%. According to US Treasury Secretary Steven Mnuchin, the unemployment rate may now be closer to 25%.
While we all know that financial markets are forward-looking and much support has been received from monetary and fiscal policies, what we are experiencing now is investors falling into a behavioural bias known as ‘Narrative Fallacy’. Narrative fallacy limits our ability to evaluate information objectively, hence we make irrational decisions. Humans can easily fall into this bias as we love stories, and the great story right now is economies are gradually restarting with lockdowns being lifted.
While we all hope that we swiftly return to pre-COVID-19 economic activity, the facts will most likely prove us wrong. Today we are starting from an incredibly low activity base. Tens or possibly hundreds of millions of jobs are already lost globally, and many will not return in a matter of months. Even for those who are still on payrolls, there is a high likelihood of elevated levels of savings curbing demand. That is still not taking into consideration a second coronavirus wave that could lead to new lockdowns if no proper treatment or vaccine is discovered yet.
How long risk assets supported by unconventional policies can defy the real economy remains an open question for now. But from where valuations are standing, it seems a lot of the good news is already priced in, and in my opinion, the best-case scenario is to see some sort of consolidation around current levels. Until confidence returns to the real economy, the rally in risk assets will not be sustainable and investors will need to reconsider their positions at some point soon.