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Why Aren’t Markets Tanking?

Christopher Smart

10 June 2020

This briefing note from Christopher Smart, chief global strategist and head of the , gets to the heart of why markets aren’t reacting to the protests and the pandemic as expected. Scenes from across the US and elsewhere over the past fortnight have raised questions about whether markets will always remain so disconnected from social turmoil, especially when corporate America, increasingly following ESG values, is getting a lot more vocal in its response. The author draws on a new body of economic research showing how inequality represents a significant drag on growth, limits the supply of new talent, entrenches anti-competitive interests and constricts potential consumer demand.

There is a list of reasons which might make an investor squirm, but there may be change afoot that they should watch closely.

Violence and vandalism sweeping American cities? Mounted police scattering protesters at the White House? The president invoking the Insurrection Act of 1807? Will nothing take the S&P 500 lower?

For many of us who stare at investment risks and returns for a living, there is a comfortable narrative of free markets driving prosperity, creating opportunity and generally makings the world a better place. Indeed, on most of those measures, the record of capitalism and democracy still look pretty good compared with the alternatives that history has tested.

But then a profound social ill rears its head which financial markets seem entirely incapable of addressing. Worse, they seem blissfully ignorant that there is even a problem. Investing, which most days feels like the engine of global progress, last week suddenly turned into a jarring distraction from the flaring symptoms of a chronic societal disease.

Here are a few possible answers for the market action, offered in rising order of how much they might make investors squirm:

1.  There’s even more money sloshing around out there than we thought. The world’s central banks continue to provide waves of liquidity, while emergency unemployment packages have helped fill gaps in household incomes as job losses spike. China’s National People’s Congress delivered a solid fiscal programme even if it didn’t wow markets, but Europe’s leaders look likely to deliver a significant increase in spending backed by joint bonds.

2. The recent COVID-19 curves are still trending in the right direction in most developed markets as prime ministers, governors and mayors gradually guide the return to work. Death counts continue to mount but are so far nothing to suggest the need for a fresh set of lockdown measures. Meanwhile, the drumbeat of tentative good news on vaccine development helps fuel a brighter outlook.

3. As for the urban protests themselves, the actual damage in large part remains limited in most cities to stores and monuments. While anger is deep, the most extreme violence looks like the work of a smaller number of troublemakers. The images from the protests are visually dramatic, but any potential damage to consumer spending and shopping patterns pales in comparison to the complete shutdown in March.

4. These protests are worse than we have seen recently, but they are also part of a long series of unrest triggered by police violence that includes Baltimore (2015), Ferguson (2014), Cincinnati (2001), Los Angeles (1992) and Miami (1980). Racism is, after all, woven deeply into a fabric of American history that some trace as far back as 1619.

5. Police brutality, racial injustice and economic inequality are separate but inter-related problems. There is a fascinating new body of economic research that shows how inequality represents a significant drag on growth, limiting the supply of new talent, entrenching anti-competitive interests and constricting potential consumer demand. Yet, ultimately, the stock market reflects the prospects for growth in economic wealth and thus remains mostly unaffected by what goes on where there is less of it.

These uncomfortable answers raise a much deeper question about whether markets will always remain so disconnected from social turmoil.

Small sparks can start unexpected fires that engulf the status quo. But nothing on America’s streets so far looks like revolution. A cynic would also point out that political change won’t be urgent as long as stocks are rising.

The causes of racism are maddeningly complicated and entrenched. They are fuelled by personal fears and prejudices that are often unseen and unacknowledged. They are aggravated by organisational incentives that may intend to reward inclusion and diversity but struggle to make progress amid many competing concerns. They are magnified on a political level, where the differences are often exploited by leaders looking for votes. Recent events could give further impetus to Democrats this autumn if they win on a wave of African-American votes, but significant legislation will be hard-fought and laws won’t change attitudes.

Still, there may be a glimmer of change afoot in corporate America that could more closely link social progress to financial markets. Amid rising concern for environmental, social and governance (ESG) records, corporate policies on racial inclusion will surely move up the list.
Even as Republican and Democratic politicians traded sharply different versions of recent events, it was notable to hear CEOs who didn’t feel constrained to issue carefully balanced statements. Cisco’s CEO denounced “systemic racism.” Retailers including Nordstrom and J. Crew joined in “Blackout Tuesday,” a social media protest launched by the music industry. The Business Roundtable CEOs issued a “stand against racial injustice.” There were fresh contributions to non-profits committed to ending racial discrimination and calls for employees to raise the issue in conversation rather than pretending it doesn’t exist.

It will be a while before stock valuations are directly linked to corporate social agendas, but American corporations may actually deliver more progress over time than gridlocked politicians. Arguably, the political gridlock itself cannot end without more direct pressure from corporations themselves. Meanwhile, investors should stay alert for signs that markets may start more closely reflecting the deep complexity of America’s social virtues and ills.