Market vs. Economy
Gary Matthews
Much is being made in the news media of the apparent disconnect between the capital markets and the economy. As the pandemic unfolds, unemployment in the U.S. and elsewhere in the developed world has soared to heights not seen since the Great Depression. Corporate earnings are also hemorrhaging as the global economy has been hobbled on an unprecedented scale.
Meanwhile, the stock market, after taking a major hit in March, had a great month in April. The S&P 500 jumped 12.7% for the month, with all eleven of the sectors gaining during the period. Only 29 stocks in the broad index showed a loss in April. This was the best monthly performance since January 1987—and the S&P was not alone. The technology-heavy Nasdaq Composite gained 15.4% for the month, its best performance since the height of the tech mania in June 2000. After March, who would have predicted April’s market performance?
It is easy to assume this disconnect is simply one more example of this unprecedented time of chaos in our modern history. A more reliable interpretation is that we are seeing a clear and well-documented illustration of two very different perspectives from which to view the financial world in which we live.
Let’s take a closer look. The market reflects the collective behavior of all of the world’s investors – individuals, banks, portfolio managers, insurance companies, endowments, etc. Investors (especially professional and institutional traders) are looking forward in time, seeking to anticipate what stock prices will do based on reasonable assumptions about the present and predicted health of both corporations and individuals (as consumers). What we know of the economy, on the other hand, is largely based on what economists tell us. Economists are looking primarily backward in time. They look at historical data (ex. the changes in unemployment over the past three months) in order to interpret the present health of corporations and individuals.
Thus, with the coronavirus still virulent, recent corporate earnings plummeting, and unemployment skyrocketing, the economists are painting a very dark picture of the present and near-term economy. We are even seeing that dreaded word again – depression. The market, on the contrary, seems to be making a different bet. Investors, collectively, are anticipating the re-opening of society and the eventual decline, or playing out, of the public health damage currently being caused by the coronavirus. Economists are looking at the abyss, investors at a clearing sky.
No one would be surprised if the market turns around again and heads back, at least for a time, in the direction of current corporate earnings. Yet, consider – the market has been a leading indicator for the economy for many years. We know the economy moves in cycles of expansion and contraction. We also know that when the economy reaches its cyclical peak expansion the market, historically, has often already begun a descent into bear market territory, anticipating a coming recession. On the contrary, when the economy has hit bottom in the past, the market has usually already anticipated the coming recovery and begun its move toward a bull market. While it is reasonable to think the market will follow the economy, historically it has usually been the other way around.
Who better interprets the economy, economists or the market (the collective intuition of investors)? This pandemic, understandably, makes us feel like the rules have changed. It is hard to trust anything we think we know. The economists have announced a recession, one that could last awhile. To which I want to say, uncharitably – no kidding! Meanwhile, the market is about, and might already be, predicting the economic recovery before it happens, and before the economists even begin to recognize it. So, while the market is still well off its peak, and whether the recovery comes sooner or later, I want to be in the market now.