In the midst of covid eruptions and restrictions, the stock market is once again breaking records

Another month, another record in the stock market. The second (or third) wave of covid has swept across the world. And politicians have – quite predictably – responded again by rolling out a number of restrictions on mobility in an attempt to ease the pressure on health care.

As a result of the arrival of the second wave, we have also seen economic forecasts outside the US downgrade, as economists realize that we are unlikely to see a full reopening before Easter. None of this, however, seems to go on the stock market – instead, it rides high on the backs of help from politicians and central banks.

The last days of 2020 and the first of the new year have proven to offer almost as much action and surprises as the past year.

Happy divorce – for now

The Brexit negotiations came to a – so far then – happy ending. By agreeing on a friendly divorce, Britain and the EU have avoided a worst case scenario that would have created major problems in both economies.

But even though the result could undoubtedly have been much worse than it was, the pictures of the long queues of trucks at Dover help to emphasize that, after all, there will be a bill to pay on both sides of the canal.

And the TV pictures even tell only about the part of the economy that has to do with goods. When it comes to cross-border exchange of services, things have fundamentally changed to a degree of inconvenience that current lockdowns may prevent many firms from fully understanding yet.

There is little doubt that the economic blow from the divorce will hit the level of activity in both the EU and the UK in the coming months. From a purely data point of view, however, it will drown completely in the noise from the shutdowns.

US Treasury reopened

There was also good news other than a reasonably good divorce for Christmas – the US Congress delivered a $ 900 billion stimulus package. Both the scope and timing of the package were, as I see it, positive surprises.

Firstly, the package was adopted in time for the money – which includes checks directly to the citizens – to be used during the winter months. This is crucial, as it is precisely in these months that the economy will need support the most, all the while wading below covid constraints.

When spring comes, the restrictions can be eased, and thus the need for support also becomes less acute.

Second, the package was somewhat larger than what there was consensus that one could wait. As I see it, the grant agreement provides a very solid plank on which the economy can stay afloat until the summer months come, and the restrictions may perhaps be completely removed again – hopefully permanently.

Political support is also something the US Federal Reserve can use for something. The members of the bank’s central committee have been rather nervous about the prospect of political paralysis in relation to fiscal easing.

The fact that something has finally happened has clearly reduced the stress level of the committee. This can be directly read from the talk that has suddenly arisen about perhaps reducing the size of the support purchases in the private market that the US Federal Reserve is responsible for.

Those discussions, as I see it, are probably still a post or two too early – but they underscore a clear risk to a stock market maintained by an ultra-monetary policy.

Decisive majority for the Democrats

At the same time, something has happened in the state of Georgia that stock markets have traditionally taken a stand on: The Democratic Party has – with the two rather unexpected Senate election victories – been given significantly better conditions to implement a policy that increases regulation and redistribution in society.

And with the Biden administration’s plans for increased public spending and higher taxes on business and people with above-average incomes, the plan is largely as it used to be.

But after some hesitation, the market has actually accepted the Democrats ‘victory without seriously hesitating – and even found some consolation in the fact that the Democrats’ paper-thin majority in the Senate hardly leaves room for the more progressive parts of Biden’s plans to go through.

As an economist, I believe that the positive aspect of a government that controls both parts of Congress and at the same time the presidency is the ability to implement legislation. On the other hand, I am somewhat less convinced that all the more progressive ideas are being cleared out of Biden’s agenda.

For while the incoming president cannot tolerate losing as much as one vote in the Senate and therefore must be covered by his party’s moderate wing, the same is true of the more left-wing part of the party, which must also be kept satisfied. For me, the taxes will thus increase – perhaps even with a retroactive effect, so it applies already from January 2021.

At the same time, the increased opportunities for political action provided by the unification of power in one party have led to fluctuations in the bond markets. Here, the fear – correctly as I see it – has been that the state’s increased opportunity to consume will create an economy which, when we enter the second half of the year, may begin to show signs of overheating.

Such a development challenges the central bank’s promises to keep interest rates low well into the future.

Good foundation for stocks

The tremors in the bond markets and the prospect of a markedly stronger cyclical recovery in the latter half of the year have been and will continue to be the driving force behind a very strong rotation in the stock markets. If you look at which stocks are rising in the indices, both cyclical and value stocks are thus in the process of a spectacular upturn, as they stand to gain the most from rising commodity prices and steeper yield curves.

However, the fact that the bond market is rather volatile also underlines one of the biggest risks for the stock market, as the valuations of many shares are already generous. The central bank’s acquisition program holds a strong and calm hand under the market – but one day that support must be withdrawn. Fortunately, however, this is not the case and is hardly relevant until the pandemic is under control.

Overall, this means that even if the covid eruptions trigger economic fluctuations, the underlying direction is still that the world economy is in the early stages of an economic recovery – and in those stages, equities are likely to rise.

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