Markets are coming back down to earth

The same problem of interpretation arises with typical diffusion surveys, such as the German ZEW. We have seen over the past few weeks a strong jump in expectations in various diffusion surveys. This jump does not mean confidence is back. Investors need to keep in mind that those questioned are merely asked to compare with how expectations are relative to the past month. Expectations are improving, but this is mostly because it cannot be worse – they are improving from an utter stand-still!

Investors will have to learn to navigate in a more uncertain economic environment than ever before. Economic forecasting has been proved to be very difficult in the pandemic. It explains why there is so much divergence between economic forecasts. For instance, the current forecast spread among analysts for Brazil range from -1.8% to -8% this year (based on 36 available GDP forecasts) and for China, it ranges from -3% to +3,5% this year (based on 74 available GDP forecasts).

We observe the same issue with U.S. forecasts. For 2021, the forecast spread between FOMC members has never been that important to my knowledge. The most pessimistic member expects that the economy will be in recession (GDP at -1%) while the most optimistic expects it will grow by +7%. The same gap exists for unemployment forecast: it could move either to 4.5% or to 12% next year.

Not saying that the market has paid much attention to economic data over the past ten years but, as a matter of fact, it usually strongly guides monetary policy action which is probably one of the main drivers of the stock market. This major divergence is mostly explained by the fact economic models are not able to integrate the pandemic factor and the inherent economic impact that is massive. Said differently, economists are not epidemiologists and since we have never faced such a major global pandemic since WWII, we don’t know how it will really affect consumption and investment behavior (e.g. hysteresis effect or not?). We know the outlook is very grim for the coming months – Q1 GDP was awful but the worst is still to come with Q2 GDP to be released soon. But we don’t have much clue regarding the shape and the speed of the recovery that will depend on the impact of the second wave and the efficiency of monetary and fiscal policy. Finally, in the long run, the only factor that might really matters for investors in the equity market might be liquidity, and so far it has been surging.