What Drives the US Stock Market in the Context of COVID-19: Fundamentals or Investors’ Emotions?

Abstract

The US stock market has displayed considerable excess volatility during the different waves of the COVID-19 pandemic. Notably, while most US indexes fell abruptly and lost about 20–30% during the first wave and in times of lockdowns, unlike the global financial crisis of 2008–2009, the correction was rapid, and most stock indexes subsequently exceeded their pre-COVID levels. Accordingly, it is important to assess whether this dynamic is driven more by a switch in fundamentals or whether it is simply due to a conversion of investors’ emotions. This chapter aims to analyze the dynamics of the US (S&P500) stock index, both before and during the ongoing coronavirus pandemic. Our findings point to three interesting results. First, US stock returns are driven by both macrofinancial and behavioral factors. Second, a two-regime multifactorial model reproduces the dynamics of the US market in which financial factors play a key role whatever the regime is, while the impact of behavioral factors appears more significant only in the second regime when investors’ anxiety exceeds a given threshold. Third, our in-sample forecasts point to the superiority of our nonlinear multifactorial model to forecast the dynamics of the US stock market.