What to Make of the Stock Market

Covid-19, social unrest, an urgent national conversation about systemic racism. None of these issues seem to go along with surging stock prices. Even though stocks fell last week, how is it possible for the stock market to rise so fast given all that seems to be going wrong in the world? What are realistic expectations for stocks going forward? Let’s spend a few minutes addressing these questions.

Among all the news lately you might have missed how the government agency that tracks recessions announced that a recession began in late-February. I don’t think this comes as news to anyone, but it’s good to know when these things start and stop. What seemed strange at the time was how the announcement coincided with major stock indexes like the S&P 500 getting back to even for the year. I’m going from memory, but stocks were up on the date of the announcement as well. It just added to the weirdness factor of stocks rising in the face of so many negative headlines.

As we’ve discussed before the stock market isn’t the economy. It can seem like it is because the changing values of major indexes like the Dow and NASDAQ are quoted in the news every business day. Instead, it’s a place (in the most general sense of the word) where investors buy and sell company stock based on expectations about the health of the economy and how public companies will perform over time. I emphasize public because only about 1% of our country’s businesses are publicly held and traded on stock exchanges, according to the National Bureau of Economic Research (the same agency that calls recessions, by the way). Even though the percentage is small, it’s a diverse list of thousands of businesses that employ roughly 1/3rd of the country. So, while these companies are obviously not the real economy all by themselves, their performance in the stock market serves as a good temperature check on how things are going in the business world.

But the stock market is still just a market filled with buyers and sellers (and a lot of computer algorithms, of course) who are normally rational and look past the day’s non-financial headlines. This might sound unfeeling, but if you think about it that’s exactly how it should sound. While markets are prone to bouts of manic depression and irrational exuberance, they are still based on dollars and cents fundamentals and always, eventually, come back to them. When investors have what they think is good information, they put their rational hats on and their confidence shows up as relatively stable, rising prices for stocks. But when investors start losing confidence in their information, well, that’s when the wheels start coming off.

Case in point is our current situation. Stock prices briefly made it back to even year-to-date two weeks ago after a massive run from the lows of mid-March. Investors during this period were feeling a tailwind from Federal Reserve policy, the huge stimulus bill and, at least in May, positive developments in coronavirus numbers. Add in some better-then-expected news about the economy and investors were pricing in a V-shaped recovery, assuming that we’d be back to normal by year’s end. And we were already assumed to be in a recession, which was why making it official was such a nonevent.

But then states like Texas and Arizona started reporting upticks in virus cases as June began. This rekindled fears of a second round of shutdowns later this year, which obviously would be bad for everyone. Investors quickly realized they had gotten ahead of themselves in the recent rally and began taking profits last week. This sent stock prices down by the largest amount since the dark days of March.

These recent weeks are instructive regarding what to expect going forward. As we discussed previously, recovering from the self-induced coma we’ve put ourselves in is likely to look more like a jagged Nike Swoosh than a V shape. Housing, for example, is doing quite well nationally since interest rates are extremely low. This helps homeowners feel wealthier, allowing them to be mobile and spend more money. This in turn helps fuel our consumption-based economy but does little, of course, for someone who doesn’t own a home or have a solid job. Restaurant owners in Texas, for example, have the opportunity of being open but are still experiencing a 45% decline in reservations compared to this time last year, according to the booking website OpenTable. How long can a business survive in conditions like that? There are tons of mixed messages like these coming from all over our economy. This is likely to last awhile and perpetuate uncertainty.

Because of this we, as investors in the stock and bond markets, should expect more short-term market declines as we climb up the Swoosh, so to speak. Hopefully, they won’t be anything close to what we experienced in February and March. Those were historic moves. But couple the uncertainties of our current situation with the historic reality that secondary drops typically follow major market declines, and we’d be silly not to expect a bumpy road ahead.

Have questions? Ask me. I can help.

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