Equities are forward-looking and discount future earnings. They will peak and reverse before the real economic numbers. The large April return reversal, up 12.8 percent for the month, is sending a message of optimism that seems premature. There is no national agreement on reversing the Great Lockdown. A state by state opening will ensure that any reversal will not be a single step process but a gradual stair step process. Confidence is down. Investment is down. Consumer spending is down. Unemployment is expected to hit 16 percent with the next report. All of these economic declines have generally been greater than anticipated by the market forecasts.
What is driving equities are the non-real measures that drive markets. Volatility is declining. Financial stress as measured by the Fed bank stress indices is falling. Economic policy and equity market uncertainty as measured by news indices have stabilized or are falling. The Chicago Fed financial conditions index has improved from highs in March. These numbers indicate room for optimism.
While earnings have been reported for the first quarter, they show only a partial impact from COVID-19, so it is hard to tell what the rest of 2020 will look like. The full impact of the lockdown will not show in the numbers until July. We have to rely on investor optimism over current real data pessimism if this rally is to continue.
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