Losses in the main US stock indexes on Friday will go down in history simply as small ones in an otherwise choppy week. But assessed in more detail, they provide a remarkable example of the intense tug-of-war that now grips markets and will most likely persist, if not intensify, in the weeks ahead.
Two news developments dominated the runup to the US market opening Friday.
First and foremost was the middle-of-the-night tweet from President Donald Trump confirming that he and his wife had tested positive for COVID-19. The immediate reaction in the futures market included an indication of a 500-point drop in the Dow Jones Industrial Average at the open consistent with uncertainties triggered by the news -- from concerns about their health and that of other White House and congressional officials, as well as that of former Vice President Joe Biden, to the implications for the elections, fiscal stimulus and the economy. Few readily available answers cast an even larger cloud of unpredictability over the economy and markets.
An hour before markets opened, investors received a second piece of unsettling news from the monthly US jobs report. Employment creation in September fell short of consensus expectations, amounting to less than half the tally for August. This confirmed other indicators that have suggested that the pace of the economic recovery is moderating, falling further behind what is both needed and possible. And while the unemployment rate did decline, it did so in the context of a notable deterioration in labor force participation as discouraged workers exited -- thereby further extending worries about economic well-being from the recent past to actual and future growth.
Despite all this, the losses registered by the Dow and S&P 500 Index were relatively limited when the market opened. The Dow even traded in positive territory for a while before ending the session only 134 points lower, or 0.5 percent, with the S&P losing 1 percent. While the tech-heavy Nasdaq index underperformed, giving up 2.2 percent for the session, it was against the backdrop of a remarkable year-to-date outperformance with an overall gain of 23 percent compared with the S&P’s 4 percent and the Dow’s loss of 3 percent.
News over the weekend compounded some of Friday’s initial uncertainties. President Trump’s move Friday to Walter Reed hospital was followed by mixed news Saturday about his progress in battling the virus. More Washington officials, as well as highly visible officials such as former New Jersey Gov. Chris Christie, tested positive for COVID-19. Senate leaders indicated that their deliberations over the next two weeks would be heavily curtailed because of the virus.
All this serves to crystalize further for most Americans, and more people around the world, the risks and implications of COVID-19. After all, if even the president of the most powerful country in the world is vulnerable, how exposed is each of us? With that, individual and collective perceptions of what I think of as “human counterparty risk” increases, casting an even larger cloud over prospects for consumption and demand, the viability of certain service sector activities and the overall economic recovery. This comes when there is little likelihood of the US Congress passing a new fiscal package that both provides relief to suffering Americans and helps with the challenging task of “living with COVID” as scientists scramble to invent therapies and vaccines.
The options markets are closer than the cash market in reflecting the uncertainties. Judging from both the shape of the VIX’s future curve and the balance of calls and puts activity last week, options traders are positioning for increasing multimonth volatility with more likelihood of downward pressure on asset prices. The cash market is not there yet. Its deeply entrenched conditioning -- that of buying the dip because of a lack of alternatives to stocks and fear of missing out on attractive opportunities -- has continued to act, at least so far, as a long-standing offset to unsettled fundamentals.
And behind this conditioning is the seemingly unshakable willingness of systemically important central banks to be ample and reliable injectors of liquidity, with almost total disregard as to the consequences of increasingly disconnecting financial markets (“Wall Street”) from economic realities (“Main Street”), including in terms of inequality and future financial stability.
The evolution of this increasingly unstable cocktail will go a long way in determining the well-being not only of investment portfolios but the global economy. The hope is that investors’ persistent liquidity conditioning will act as a bridge to improving fundamentals that will validate currently elevated asset prices and propel them on a firmer long-term footing. The concern is that financial instability will add to the headwinds undermining a much-needed economic recovery that is strong, sustainable and inclusive.
Mohamed A. El-Erian
Mohamed A. El-Erian is a Bloomberg Opinion columnist. -- Ed.