Market Economy Disconnect
/Why is there a disconnect between the market and the economy?
As 2020 began, it looked like we were headed for another record-breaking year in the stock market. The Dow was just shy of hitting 30,000 in February 2020 before the coronavirus became a real threat, causing the stock market to drop 37% from its all-time high in just 39 days. It was the most rapid decline in history. Just 12 days after that, the market recovered—somewhat—and we were down just 20% from that same high. To put this into perspective, in 2008-09, the stock market dropped to 10-year lows, and in 2020 it dropped to 3-year lows, which quickly became 2-year lows.
This left many scratching their head asking what changed. It didn’t make sense because during that same time period we were watching stores, restaurants, schools, libraries, airlines, hotels, and many other businesses either temporarily close or scale down to barely keeping the lights on. States were telling their people to shelter in place. All of this resulted in unemployment skyrocketing to 15% and GDP falling an estimated 30% for second quarter.
So why would the stock market start to move upward while the economy was on a downward slope?
To put this into perspective, let me ask you something: Have you ever owned a stock that had a poor quarterly earnings report but still gained in value that day?
If so, it’s most likely because the poor earnings report was expected. It was already baked into the stock price. At the same time, the company’s future looked bright. So, the stock was rewarded. A stock’s value is based on earnings and the potential growth of earnings.
To apply this logic to today, the stock market is a leading indicator. It tells us what the economy may do in the future. By moving up, it just told us it anticipates economic growth. But how can that be when the most important indicator of economic growth is employment? With 15% of the population unemployed, we can only assume that the stock market has baked this number into its valuation and expects the economy’s future to be brighter than it is today. The economy will have to navigate many bumps in the road ahead, but we are hopeful for a much brighter future.
