February 2021 was a strong month for global equity markets. Vaccine optimism coupled with strong Q4 2020 earnings led to major indices and sectors outperforming.
The yearly return is positive for most equity markets and sectors, with one obvious exception – the United Kingdom. Brexit loomed large in 2020 in the U.K, equities, and perhaps 2021 will be the year responsible for reducing the lag?
The Positive Effects of a Rising Stock Market
When interpreting the business cycle, the analyst has various indicators at her disposal – leading, coincident, or lagging. All of them have their place in the analysis, but for obvious reasons, the leading indicators are closely watched, especially when it is believed that the cycle is bottoming or it is at its peak.
The stock market is one of the leading indicators. It is said that it leads the economic recovery by about six months or so. Curiously enough, if we have a look at the U.S. stock market indices and the U.S. economy, we may say that the theory of the business cycle works like a charm. After all, the markets bottomed last April, and by the end of December 2020/January 2021, the U.S. economy already delivered some impressive economic data. I would mention here the staggering rise in Retails Sales in January, showing that consumer spending is alive and kicking, and the decline in the initial unemployment claims seen in February.
The unemployment rate and other labor market indicators, for instance, are lagging indicators. They lag the recovery by a few months, so using this assumption, we are back to December 2020 or so as to when the economy bottomed and the business cycle turned.
Sure, the fiscal and monetary response from governments and central banks around the world fueled the stock market indices. In some cases, central banks intervene directly (e.g., Japan) by purchasing ETFs and stakes in major local corporations. In some other cases, a big part of the fiscal stimulus received by the population ended up in the stock market.
All in all, a rising stock market is the first positive sign ahead of sustained economic recovery. Put it simply, you cannot have one without the other. Therefore, before shorting the stock market, think if it bodes well with the theory of the business cycle. If the stock markets decline, the move lower may signal another economic contraction in about six months from now.