The global economy has been hit hard due to the outbreak of COVID-19 pandemic and it cast a shadow over the prospect of economic recovery.Unemployment may be peaking in part because the COVID-19 pandemic spread and many states in US stopped to reopen their economies.However, the performance of the US stock market is exceptionally good and Dow Jones and Nasdaq continue to hit record highs. Why does US stocks keep rising in this kind of serious situation? 

 FED POLICY

With the spread of the COVID-19 pandemic in the United States, the Fed has implemented massive stimulus plans in 2020. Firstly, Federal Reserve cuts rates to zero and launches massive quantitative easing program, so any investors chasing yields have to enter the stock market.

Photo:CNBC

The Federal Reserve established the Primary Market Corporate Credit Facility (PMCCF) to support credit to employers through bond and loan issuances.The PMCCF will provide companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic.

The Federal Reserve has been purchasing US Treasury bonds at a rate of about US$4 billion per day since June;

To bolster the effectiveness of the Small Business Administration's Paycheck Protection Program (PPP), the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. 

Correlation between the Fed balance sheet and the U.S. stock market. 

Source: Preston Pysh

The market generally believes that the Fed’s stimulus measures are one of the key factors driving the stock market rebound. As the epidemic spreads in the United States, the Fed has introduced unprecedented massive stimulus measures in 2020, but this may cause the stock market bubble to blow, because the information reflected by US stocks and US economic fundamentals is disconnected.

IPO

A record $184 billion was raised in U.S. equity capital markets in the second quarter, according to Refinitiv IFR data. Over $8.9 billion worth of IPOs in the second quarter priced above the target range, the highest amount since the third quarter of 2014, according to Dealogic.

Number of U.S. IPOs since the second quarter of 2015

Photo: Internet

The data shows that as the US stock market rebounded, the total issuance of US stocks in the entire market (new listings, secondary issuances, block transactions) reached US$65.5 billion in May, the highest monthly issuance record in history, and various companies also ushered in rare Listing window period. As of now, this year’s US IPO companies are mainly technology and medical companies. 

The strong performance of the IPO market also reflects investor optimism. U.S. stocks have rebounded strongly in recent times. However, some market participants are concerned that the current US stock market gains may not be sustainable. Companies with listing plans are “accelerating” the process to complete the listing before the November US election. Investors generally worry that as the US election approaches, the entire market will become unstable again.

BOND

In the short term, affected by market risk sentiment, stocks and bonds are negatively correlated. When market risk aversion is strong, investors will sell stocks and put funds in more insurance bonds, which will cause bond prices to rise and stock prices to fall. Conversely, if investors' risk-chasing sentiment increases, funds withdrawn from the bond market will flow into the stock market, causing stock prices to rise and bond prices to fall. But this year the US stock market rose, but the bond market did not fall.

source：Bloomberg

The Fed’s bond purchase program encouraged companies to make full use of the credit market, in the first half of this year, the US corporate world issued a total of about US$1.2 trillion worth of investment-grade bonds, a record high.Some $1.2 trillion of investment-grade paper was sold in the first half of the year, the highest issuance volume recorded by the Securities Industry and Financial Markets Association. Even though the Fed refrained from buying most junk-rated bonds, issuance was at $200 billion through June, more than double last year’s rate.

“Investment grade and high yield bonds had an incredible quarter in terms of issuance and performance. We just continue to see more and more money flow into those markets,” said Ted Swimmer, head of capital markets at Citizen’s Commercial Banking.

The premiums investors demand for holding riskier corporate debt over safer Treasury bonds, or credit spreads, narrowed sharply in the second quarter. On March 23, investors were paid the highest premium in 11 years to hold junk-rated debt, as measured by the ICE/BofA high-yield index. That number nearly halved by the end of the second quarter.

Investment-grade debt, using the equivalent ICE/BofA index has recovered almost fully from 401 basis points on March 23 to 152 basis points today.

Sufficient liquidity and stable policy expectations are supported at the same time. The interest rate of short-end funds remained stable. With the reduction of policy interest rates, the yield of short-term treasury bonds was close to zero. In addition, the Fed's discussion and prediction of the medium-term policy interest rate outlook and yield curve control policy have given market stability expectations while reducing the term premium.