As COVID-19 wreaks havoc across the country, the economy is in a crisis of unprecedented proportions. Millions of Americans have filed for unemployment, businesses have filed for bankruptcy and retail sales have plummeted. We haven’t seen the economy in such shambles since the Great Depression.
And, yet, for five straight months, while COVID cases continued surging across the globe, markets were booming. The S&P 500 index shows skyrocketing numbers — the best in decades. But why? Some debate whether the economy and the markets have an inextricable relationship, but most agree that, if the economy is in bad shape, people won’t have money to spend. Right?
Sorta. (See our newsletter, Investing Reimagined.)
You’ve probably heard it before: The economy and the market are not one and the same. Simply, while the market and the economy are inextricably linked — and, in many ways, rely on each other to forward the country’s economic progress — they perform in opposite directions under the right circumstances. COVID-19 happens to be that perfect storm.
With that said, here are three reasons that could explain why the markets are booming while the economy is… not.
1. The economy and the stock market are different.
The economy is the umbrella under which industry and money is all organized. It’s a system of supply and demand for products and services. Employment and production growth ultimately measure the health of the economy.
On the other hand, markets are where stocks (shares of a portion of ownership of a company) and other financial instruments are bought and sold; they’re essentially a piece of the economy. When we talk about the markets, we are typically referring to the stock market.
So, while the economy is the network of products and services, markets are where investors bet on and purchase ownership of the companies that provide those products and services. Markets don’t necessarily reflect the industries they represent. And the stock market, in particular, runs on mass sentiment and optimism rather than a firm reality. Because of society’s collective, staunch belief that good times are ahead — fueled by cycling news events and corporate practices — markets have to at some point pick up again. As the saying goes, “the market will always perform… eventually.” Of course, individual stocks won’t always perform and companies are not guaranteed to succeed, but the market, as a whole, will sort itself out in due time.
It’s, therefore, possible for the economy to go south while the market moves in the opposite direction.
2. Stock prices are based on future predictions, not the present.
Investors take bets on where the economy is heading, not where it’s been or where it is. And, as the New York Times’ Neil Irwin puts it, everything about the COVID-19 crisis has happened quickly, “with the economy going from full health to devastating recession within weeks.” Similarly, financial markets are adjusting to possibilities.
“Financial markets are betting that there is some reasonable approximation of normal on some foreseeable horizon,” he writes. “The current pricing assumes that a cascading series of failures will not happen. That widespread job losses and drops in income won’t cause the mass closure of businesses. That people will have a job to go back to and will be willing to spend when the public health crisis ebbs.”
In a bear market or recession, stocks tend to bounce back once a recovery seems plausible — even before the economy picks up again. And government assistance from Congress and the Federal Reserve is helping to keep the economy from the verge of another Great Depression, giving people a light at the end of the tunnel.
Even if things don’t turn around and most Americans can’t stem the tides, most stock ownership is in the hands of the wealthy who can afford to buy stocks, face higher risks and eat greater losses. Recent reports from the Federal Reserve suggest that the top 10 percent of wealthy households own 84 percent of all household stocks by value. Moreover, the top one percent hold 40 percent of stock ownership alone. This demographic of investors is less likely to be impacted by an economic recession.
3. The S&P 500 isn’t everything.
Some of the biggest tech stocks — Microsoft, Apple, Amazon.com, Alphabet and Facebook, which account for more than 20 percent of the S&P 500 — are benefiting Americans sheltering in place, ordering essentials online and working from home during the COVID-19 pandemic. So stock prices in these companies are, naturally, increasing.
But the soaring numbers for such companies doesn’t necessarily reflect the reality for the smaller companies that are still struggling. Not all stock prices are doing so well, but we tend to look at the top of the S&P 500 to determine the health of the market. While it may appear that the stock market is booming as a whole, this doesn’t mean that all stocks are on the uptick.