How the Coronavirus Affects Stock Prices and Growth Expectations

The new coronavirus has caused a pandemic of COVID-19, a respiratory disease for which vaccines and targeted therapeutic treatments are unavailable. The outbreak has created major public-health crises around the world. At the same time, there are growing concerns about the economic consequences as households are required to stay home to slow the spread of the virus. The impact that “pausing” may have on supply chains, households’ demand, and the financial stability of the economy is largely unknown. As a result, policy makers, businesses, and market participants are revising growth expectations for the years to come.

The current situation is unprecedented, and it’s developing rapidly, which is why models that use macroeconomic fundamentals may miss some of the key forces—and may be too slow to update, given the frequency with which macroeconomic data become available. It has long been recognized that asset prices may generally be useful because they reflect investors’ expectations about future payoffs. In particular, the movements in the stock market have received a lot of attention. We provide a perspective on how to interpret movements in the stock market and what they tell us about growth expectations by combining it with asset pricing data from other markets.

Equity markets in the European Union and the United States dropped by as much as 30 percent between mid-February and mid-March. This is an extraordinary amount. To interpret this decline, it is useful to recall that the value of the stock market is equal to the sum of the discounted value of all future dividends. Hence, the drop is as though investors have revised downward their estimate of future profits by as much as 30 percent. However, most of the variation in the value of the stock market is due to changes in expected returns, which are used to discount future cash flows, and not to revisions in expected future growth rates. This insight brings good and bad news. The good news is that investors’ expectations did not decline as dramatically as the drop suggests. The bad news, however, is that we learn little about growth expectations by studying the stock market.

In a research paper released this March, we use data from a related market, namely dividend futures, to obtain estimates of growth expectations by maturity. Dividend futures are contracts that only pay the dividends of the aggregate stock market in a given year. In the absence of arbitrage, if we sum the price of all the dividend claims, they add to the price of the overall market.

There are two important reasons that data on dividend-futures prices are informative. First, dividend futures have historically been good forecasters of economic growth. Second, dividend futures are differentiated by maturity, just like nominal and real bonds. We use this feature of the data to provide an estimate of expected growth over the next year and to obtain a lower bound on the term structure of growth expectations by maturity.