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Is the Stock Market Disconnected From Reality?

August 12, 2020 By Mircea Vasiu

2020 so far has been full of surprises. Any planning at the start of the year had to be revised a few months later. 

Everyone in the Western world was taken by surprise by the extent of the virus spread. Authorities reacted by locking the economies down one by one. Yet, after an initial shock, the stock market recovered dramatically. All U.S. indexes are close to all-time highs, and some even managed to print all-time highs during the pandemic. Have investors lost their sense of reality?

Big Rotation to Tech Stocks

One of the biggest mistakes made by traders is that they do not consider an index’s composition when interpreting it. If, for instance, Nasdaq is at all-time highs, what are the companies that drive its rise? In an index, the weights differ, and some sectors underperform while others overperform.

The pandemic triggered a big rotation into tech stocks. As expected during the pandemic, airlines declined, losing more than 50% of their value. Resorts and casinos fell over 45% and department stores fell even more. Hence, the market did react to the pandemic and did sell stocks expected to fall due to the economic recession.

However the pandemic proved to be a golden opportunity for tech stocks. Amazon, Apple, Microsoft and alike, were suddenly seeing their numbers exploding. Think of Microsoft Teams or Amazon AWS businesses, or at Zoom Communication – they were all successful businesses prior to the coronavirus health crisis, but now we talk about a different level. A much higher one.

In other words, when billions of people (consumers) around the world change their behavior because they are forced to stay more at home, what do they do? You guessed: they browse the Internet. Hence, the Internet and phone companies should do much better than pre-crisis.

As such, Investors have flooded the market with orders to buy such companies. Hence, the general stock market, or the indexes, are back at all time highs due to the shift in consumer behavior and much bigger potential in the tech sector.

Then there is also the correlation between the markets to consider. For example, you rarely see the U.S. major stock indexes (i.e. Dow Jones, Nasdaq, S&P500), diverge on a day-to-day basis. If Nasdaq closes higher on the day, the chances are that the other two will do the same. Maybe the percentages differ, but the outcome is the same.

To sum up, the stock market is not disconnected from reality. If anything, it is more connected to it than ever.