Speaking of October surprises…
(Markets ≠ Economy)
October 9, 2020 by The Q.ai Team
This newsletter focuses on the relationship between the stock market and the economy
Everyone who returned to the city after leaving for the spring/summer
The only surprises we want to see in October:
- Weather that doesn’t drop below 60
- Pumpkins that carve themselves into the cast of Friends
- Bitcoin that randomly appears in our accounts
- COVID to vanish from thin air so we can (safely) celebrate the holiday szn
- To always pass the vibe check like this guy
If you’re looking to get into the spirit of Fall and not be surprised, here is a nifty foliage prediction map that literally nobody asked for but also seems kinda nice. No complaints over here.
This Week’s Biggest Headlines
- The city of Chicago teamed up with design firm IDEO to come up with ways to make outdoor dining a sane option this winter. Since the start of the pandemic, 44% of revenue is procured from outdoor dining. It’s a huge opportunity cost for restaurants to not partake. But, it’s only a matter of time before patrons have to retreat inside as the weather starts to become colder – and windier. After crowdsourcing 600 ideas, they determined the top three, one of which is an elaborate heated table (genius). Read more.
- Markets are fickle and respond very quickly to stimulus news. It all started on Tuesday when President Trump announced that discussions regarding an economic stimulus was off the table. This statement was made a few hours before the Federal Reserve meeting, where Jerome Powell emphasized that a stimulus is crucial to our already slow recovery. Markets responded by falling sharply. Fortunately, it now looks like a stimulus package is being discussed again. The only question is when can Americans expect it to be approved. The saga continues. Tune in next week to learn what happens next. Read more.
- The Dow is back up at its highest levels in a month. This is likely due to the optimism investors have about the stimulus. Airlines were given a last minute bail out and now shares of airline companies are trading at least 0.6% higher, but this is seen to be volatile. The smartest thing an investor can do right now is diversify. Read more.
- Square bought $50 million worth of bitcoin. What’s bitcoin worth nowadays? It’s hard to keep up. Put it this way: 4,700 makes $50 million, or 1% of the company’s total assets. This deal comes shortly after MicroStrategy, a business intelligence company, bought $400 million worth of the same cryptocurrency. While Square bought significantly less, it’s a high-profile company and Jack Dorsey is a high-profile CEO, so people care. Read more.
- Unemployment is still high. The 840,000 files first time claims last week, more signs that the economy is recovering slower than molasses. Read more.
The market ≠ the economy
Some view the stock market as a primary metric for how the economy is doing. Those people are wrong. There’s a complex relationship between the market and the economy, as well as the inherent nature of human beings, but that does not mean it’s always going to directly reflect one another. In most cases, there will be a positive correlation between the economy and the market, but there are cases (such as right now) when one outperforms the other.
Allow us to set to scene
In April 2020 alone, over 20 million people were out of work. Unemployment reached 14.7%, the highest number seen since the Great Depression.
- In the same month, the S&P 500 index showed the best numbers in three decades. In fact, in the 50 days after March 23 (the lowest point of the market crash), the S&P climbed 40%.
- While the Dow Jones and S&P 500 showed incremental gains, the tech-heavy Nasdaq outpaced the market continually as demand for remote work and entertainment showed no signs of slacking off.
- Despite all the uncertainty we’ve all had to live through, the market hasn’t repeated the tumble it took in March. And with the help of the Federal Reserve, confidence in the economy and markets remain high.
And yet – the “pandemic economy” remained. Stores closed, reopened, and closed again. States took turns breeding the next pandemic hotspot. People were still unemployed or had their hours and pay slashed.
Many are thinking, “What’s up with that? Why is the economy meh while the markets are doing better than ever?”
The Relationship Between the Markets and the Economy
Simply put, the market and the economy are inextricably linked. In many ways, they rely on each other to forward the economic progress of our country.
Sometimes it performans in opposite directions under the right circumstances. Enter: COVID-19, the perfect storm for a modern-day, real-world example.
Before we jump in, a quick review
- The economy is the network of goods and services flowing throughout a given region
- Markets are where investors place bets and purchase ownership into the companies providing these goods and services
- When we refer to “the markets,” we are typically talking about one market in particular: the stock market
Markets are not necessarily reflections of the industries they represent, but rather a reflection of how investors feel about their investments. The stock market especially, but all investable markets, run on mass sentiment and optimism, rather than a firm reality.
This means that, in the end, markets have no choice but to march forward. Quite simply, investor optimism, fueled by cycling news events and corporate practices, ensure that the overall markets will rise from the ashes and skyrocket anew.
This isn’t to say that individual stocks will always perform, or that a particular company is guaranteed to do well – just that the market as a whole will succeed in due time.
The Correlation Between Markets and Economic Performance
Part of why so many individuals (understandably) believe that the markets and the economy are the same thing is a product of our history. And for many, the stock market is a metric, or perhaps a proxy, for how the economy at large performs.
For instance, the vast majority of the time, when…
- Stock prices are continually rising, the economy is doing well right alongside them
- Stocks plunge, it’s frequently in tandem with the economy tanking
- The market trembles like a leaf, news cycles threaten the edge of a nationwide economic recession
- When the market regains its confidence, all thoughts of economic sluggishness take a backburner to the hopes of brighter days
The correlations are there until a recession hits, and the market still performs. And when you see the numbers side by side, it’s easy to see why people believe the markets and economy must be the same thing.
In fact, this correlation has been touted as fact as far back as the Great Depression.
A Quick Recap of the Real Cause of the Great Depression
- Between 1929 and 1932, the S&P tumbled 86% before it finally bottomed out
- At the same time, the economy tanked. Millions lost their jobs, people were starving, and Hoovervilles popped up from coast to coast.
- At the time, no one had access to the internet, and laws were also different, so they couldn’t read up on financial information companies and the government are required to share today
- As a result, many drew the conclusion that the stock market collapse was at least partially responsible for the Great Depression
- While correct, people didn’t examine why the stock market crashed in the first place, which was largely massive debt and market gambles on the part of everyday Americans – not anything that the market itself did unduly.
And thus, the first link was forged. This relationship has remained firmly fixed in the minds of most investors ever since, and it’s easy to see why.
So, why is the market dancing with the stars while our economy takes a journey to the center of the earth?
Markets in the Hands of the Wealth
Although almost half of all households in the U.S. own shares in some sort of investment vehicle, these accounts are typically modest. Even a full retirement savings account is usually worth, at most, a few hundred thousand dollars.
Most stock ownership lies in the hands of the wealthy, who can afford to buy and stocks casually and eat their losses to a greater extent. This group is also statistically less likely to be seriously impacted by an economic recession. In fact, recent reports from the Federal Reserve show that the top 10% of wealthy households own 84% of all household stocks by value. Furthermore, the top 1% hold 40% of stock ownership alone.
As a result of this brew – the combination of wealth concentration and its results on market performance – many economists agree that, over time, economic growth has little impact on the market, and vice versa. Rather, they are separate metrics that often happen to convey the same information.
When the metrics differ in their presentation, therefore, they show two different pictures based on two different foundations – but it takes a massive event (such as a pandemic market) to draw out those differences for the public to see.
Let’s Talk Unemployment
As we mentioned earlier, in April 2020, 20 million people lost their jobs or were furloughed into uncertainty.
It’s important to note that, as a country, we have a relatively fair expectation of unemployment: that it’s a temporary predicament and typically lasts no longer than 6 months at a time.
Until the passing of the CARES Act, individuals could only collect unemployment for 26 weeks, regardless of hardships or the economic situation. The CARES Act extended this timeframe to 39 weeks.
The continually high unemployment rate, combined with individuals fearing for their safety amidst rising coronavirus concerns, is one of the primary reasons the economy stayed depressed in the third quarter of 2020 even as markets soared. And new work isn’t always possible to find.
While wealthier individuals had the ability to purchase and sell securities at their leisure, the average American – employed or not – couldn’t afford the luxury of saving for their future.
A Quick Word on GDP
Another indicator of economic health is GDP, or gross domestic product. While this doesn’t have as strong an impact on the economy under some circumstances, it can have a disproportionately large impact in others.
However, GDP plunged 31.4% during Q2 of this year. The previous record-setting drop was in 1958, when Eisenhower was president. The drop was only 10%.
The Bottom Line?
The point is this: while the economy and the markets are not by definition the same, they are inextricably linked to a point that they affect one another in most circumstances. However, when the right conditions arise, it’s possible for the markets to move in one direction, while the economy moves in the exact opposite. In the case of coronavirus, that’s exactly what the nation saw.
If you’re as fascinated with the stock market and its relationship with the economy like we are, then you will enjoy this podcast episode featuring Jesse Livermore. Jesse explains what the Federal Reserve is currently doing to stimulate the economy (boosting spending power), what he believes the long-term outcomes could be, and introduces a different approach that he claims will provide even more spending power.