As of 15th May 2020, United States of America (USA) is the most affected country of Covid-19. The impact of Covid-19 to its economy is unprecedented. USA’s 1st quarter GDP contracted as much as 4.8%, the worst quarterly contraction since 2008 (Read more here). The WTI crude oil May futures contract fell to -$37.63 on 20 Apr 2020, the first ever negative oil price in history (Read more here). International Monetary Fund (IMF) even issued a warning on 23 March 2020 that the “Great Lockdown” impact may be more severe than the Great Depression (Read more here).
Nevertheless, the stock market seems unaffected by the gloomy outlook. Since the S&P 500 dropped about 35% from February high, it has rebounded almost 27% from its March low. Many analysts have attributed the rebound as “bear market trap” or “dead cat bounce” (Read more here), by referencing to past crisis patterns. So, is there any current data that correlates with the recent stock market rebound?
Figure 1 shows the S&P 500 and the M2 money stock (blue line) chart. Under normal circumstances, M2 money supply will increase in tandem with GDP growth. The M2 money supply was increasing at a very constant speed before March 2020 but the speed accelerated dramatically after March 2020. The sudden surge of money supply could have moved into the stock market instead of the real economy as the lockdown was still in force. This has created a dangerous gap between stock market and real economy as illustrated by The Economist (Read more here).
For now, it could take some time before the stock market reverts to the mean, reflecting the real economic condition. The biggest risk ahead would be the 2nd wave of Covid-19 due to premature reopening. And that may take the real economy and the stock market into a serious tailspin!
Figure 1: S&P 500 and M2 Money Stock