Q. A lot of investors are wondering why the markets are rallying amidst all the bad news on the economy and the health front. Why is that happening?
A. The simple answer is that the markets are really a discounting mechanism, so they’ve already discounted a lot of the bad news and are looking ahead to 2021.
When the markets fell roughly 35% between mid-February and March of this year, they priced in a lot of bad news, including a severe recession. They had also priced in the bad news we saw in late March and early April on the health front, including increased hospitalizations and deaths due to COVID-19, business shutdowns, lay-offs and rising unemployment.
Right now, the markets are rallying because they see a path to reopening and restarting the economy, with the assumption that we’ll be back to a somewhat normal state by 2021.
It’s also important to remember that when we entered this period, the economy was in good shape. So heading into the downturn, there were very few imbalances. We weren’t seeing individuals borrowing against their homes like we did heading into the Great Recession in 2007, and businesses weren’t overleveraged or saddled with debt.
In the period leading up to the global financial crisis in 2007, and the Great Depression in the 1920s, there were an extreme number of imbalances in the economy. That’s not happening now.
Q. What about the banking system? Should people be worried?
A. Heading into the Great Depression, as well as the 2007-2009 financial crisis, the health of the banking system was very poor. Following both of those difficult periods, regulations were introduced requiring the banks to adhere to strict guidelines. We’re seeing the guidelines that were put in place 10 years ago paying off today. So our banking system is in good shape to weather the storm we’re facing now.