The Economy Is Not The Stock Market

The Economy Is Not The Stock Market

So here we are….in the middle of a global pandemic.  Unemployment in the US is hovering around 15%.  Businesses are struggling to remain viable.  Hundreds of thousands of families…probably millions …are concerned they won’t be able to make their mortgage payments.

Yet, the stock market is closing in on all time highs set earlier this year.

How is that possible?  What gives?

The party line answers sound something like:

  • “Stocks prices reflect future earnings, not present earnings”
  • “COVID-19 is temporary, and our economy will return as soon as it passes”
  • “The market is just being manipulated by the Fed.  All that cash is pumping up the market”

All these are reasonable responses.  But they circumvent a very important concept that many of us seem to be forgetting recently:

The economy is not the stock market, and the stock market is not the economy.

 

I probably don’t need to throw a bunch of economic data at you to make the point that the economy right now is…..uh….not good.  But just to slam the point home, here are a couple data points to set the table.

 

1) Corporate Profits Pre-COVID

Below you’ll find the long run numbers on total corporate profits.  Notice that we have a slight dip at the very end of the chart, signifying the end of Q1 when the Coronavirus really started ramping up.  We don’t have Q2 numbers yet, meaning that we don’t know how far corporate earnings have actually fallen since the country wide shutdown really set in.

The Economy Is Not The Stock Market

Long run after tax corporate profits. Source: St. Louis Fed

 

Corporate Profits Looking Forward

We don’t have the actual Q2 numbers yet, but here are the forecasts.  This chart shows current earnings guidance from the S&P 500 companies provided by FactSet.

See all the red?

Unsurprisingly, the majority of S&P 500 companies have provided negative earnings guidance for Q2.  Again, it’s difficult to forecast the magnitude of what we’re in for here.  But it’s clear that across the board the outlook is trending down.

The Economy Is Not The Stock Market

S&P 500 Earnings Guidance. Source: FactSet

 

Unemployment

And finally, unemployment.  The time frame we’re looking at here goes back to 1950, so we’re not seeing the depression era unemployment numbers that rose as high as 25%.  At 15% currently, millions are out of work.

While there was a positive jobs number released about two weeks ago, a large portion of it was artificial.  It contained hundreds of thousands of payrolls supported by government intervention that will soon expire.  The Payroll Protection Program compels small businesses to keep their staff on payroll in the weeks following receipt of funds.  When this period ends many jobs will vanish.

The Economy Is Not The Stock Market

US Unemployment Rate Since 1950. Source: macrotrends.net

 

Meanwhile…..In Equities

The Economy Is Not The Stock Market

S&P 500 3-month performance. Source: Kwanti

So what gives?  How can stocks be up so dramatically from the depths of the end of March when unemployment is so high and earnings guidance is so low?

Say it with me now: the stock market is not the economy.  The economy is not the stock market.

The economy is comprised of a bunch of people and companies interacting with each other, exchanging goods and services for money.  When times are good we’re able to produce a healthy of amount of the goods and services our society wants and needs, in a way that provides jobs for anyone who wants one.

The stock market is where shares of publicly traded companies change hands.  When the economy is good we tend to think that those companies are worth more, because they have a better opportunity to drive profits.  But they are not attached at the hip.  Stock prices are heavily influenced by human emotion and numerous other factors.

My best guess right now is that we have two major driving forces supporting the market.  First, we’ve already spent our willpower against the Coronavirus.  Even though the data suggests that we’re still very much in the middle of the pandemic, many of us around the country have simply decided that we’re over it.  We’re tired of social distancing, tired of staying at home, and tired of avoiding public places.  And because the country is so desparate to get back to normal, we assume things will naturally trend in that direction.  This assumption that the situation will improve on its own is fueling stock prices.

Second, we have a ton of money being pumped into the system.  The fed’s balance sheet is growing rapidly, and the central bank is now buying risk assets like bond ETFs.  I’ll share one more chart to give you an idea:

The Economy Is Not The Stock Market

Fed balance sheet since 2008. Source: federalreserve.gov

See the spike on the right hand side?  That’s the federal reserve aggressively adding liquidity to the market.  A lot of this money is making its way back in to the market, and propping up prices further.

So how can the markets be up, even though we’re still in the middle of the Coronavirus pandemic?  We have exceptionally easy money right now, and a potentially dangerous false sense of security.  The markets are not the economy, and the economy is not the markets.

 

 

Posted in Financial Planning, Investing, Uncategorized and tagged , , .

One Comment

  1. Yes! Thank you.
    I have been shouting that phrase for a while. But you provided more solid data and reasoning than I do with my opinions.
    The next question that pops up is: “What does this mean in terms of my investing.” For me, it means to prepare for volatility and likely market decline. I removed some risk from my portfolio.
    I have some stocks, but only about 30% of my portfolio.
    Other recommendations or thoughts about investing in this climate?

Leave a Reply

Your email address will not be published. Required fields are marked *