Why Is the Stock Market So Strong When the Economy Is Weak? – Knowledge at Wharton
the continued strength of the stock market even as the coronavirus pandemic hits the us. uu. economy has baffled many observers. the dow jones industrials fell 30% in the first three weeks of march as covid-19 began to spread rapidly globally, but has since gained nearly 60% to current levels above 28,650. meanwhile , The USA. The economy shrank 31.7% in the April-June quarter, the Commerce Department reported last Thursday.
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During a recent segment of the Wharton Business Daily radio show on SiriusXM, Wharton Finance Professor Itay Goldstein identified three factors that explain the apparent disconnect between the stock market and the economy. (listen to the podcast above).
Reading: Why is the stock market doing so well
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The first, which is true at all times, is that “the stock market is meant to be forward-looking,” Goldstein said. “Overall, the stock market is a little bit different from the economy, in the sense that what you see right now in the economy is what’s happening right now,” such as output, employment, etc., he pointed out. Even in “normal times,” stock prices and economic output would not move in tandem, according to Goldstein. in fact, we can have situations “where stock prices can predict something that is going to be different from what we see now.”
Second, the Fed has “put a lot of money into the market, and that certainly helps keep prices high, perhaps above what we would expect without this intervention,” Goldstein said.
“the fact that the federal reserve started to pump all this money into the market pushed up prices”. -itay goldstein
“what the federal reserve is doing right now is unprecedented,” he continued. The Federal Reserve has continued on the low interest rate trajectory since mid-2019, but has also continued its “quantitative easing” approach to injecting liquidity into the financial system, which it had used after the 2008 financial crisis. 2009. “In recent months, it is not only doing the traditional quantitative easing of buying Treasuries and mortgage-backed securities, but also continuing to buy other assets like corporate bonds, something the Fed hasn’t done before.”
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In March, in response to the pandemic, the Federal Reserve announced a stimulus package that included expanded windows for purchasing securities and new lines of credit for businesses and municipalities.
“The fact that the Federal Reserve started pumping all this money into the market pushed prices up,” Goldstein said. asset prices are “mechanically pushed up” by the feds’ buying act. That drives the prices of other assets up, too, “because investors are always looking for places to put their money,” he added.
last thursday, federal reserve chairman jerome powell spoke of a change in his inflation targets, “indicating that he wanted inflation to rise slightly above his 2% target,” as one report put it from the wall street journal. that essentially “marks the beginning of a longer era of lower rates,” the magazine noted. Stocks were mixed in their reaction to Powell’s comments, but generally trended higher.
“persistently low inflation can pose serious risks to the economy,” powell said. “Inflation falling below the desired level can lead to an unwanted drop in long-term inflation expectations, which, in turn, can cause actual inflation to fall further, resulting in a cycle adverse inflation and increasingly low inflation expectations”. The Fed was clearly concerned about the US perspective. Facing a sustained period of low inflation, a trap that caught Japan and Europe, the magazine article said.
“powell’s statement reinforces the expectation that the federal reserve will continue to have very low interest rates for some time, which will continue to be a force driving up market prices,” goldstein told knowledge at wharton. “There was nothing in the statement that would change things in the short term. But the change in framework that was described implies that the Fed will not quickly raise rates when inflation starts to rise. therefore, one should expect rates to stay low longer.”
Certainly, stock markets are factoring in expectations that the us will continue to grow. the economy is set to recover 20% or more in the current third quarter, with lockdowns lifted and modest economic activity resuming in many parts of the country. The latest count of jobless claims also brought joy, as it fell to 1 million in the week ending August 22, a sharp reversal from the peak of 7 million in March; however, it is five times higher than pre-pandemic levels of around 200,000 per week.
apples and oranges
The third factor is the fact that “the stock market is a collection of companies that is not necessarily representative of the economy as a whole,” Goldstein said. “That’s amplified these days.”
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“stocks that are doing very well (google, facebook, amazon, microsoft, netflix) have not been affected as much by current economic conditions.” -itay goldstein
In fact, stocks that have been gaining strength don’t really reflect the pain of the pandemic. “in particular, stocks that are doing very well (google, facebook, amazon, microsoft, netflix) have not been affected as much by current economic conditions. some of them may have benefited from them. they are very dominant in the stock market, but they don’t necessarily represent the economy as a whole.”
The disconnection extends to the participation of these companies in employment or other macroeconomic parameters. “It’s very easy to look at the stock market, see those headlines, see those companies are doing very well and driving the market higher,” Goldstein said. “But at the same time, their contribution to the economy in general is not that great.”
In addition, Goldstein noted that many small businesses are hurt by current economic conditions. “It’s certainly affecting the employment data, the production data, but you don’t see it anywhere in the stock market,” he said. “In general, small companies do not have access to the stock market…. You see they are closing. they’re laying off people, etc., but you don’t see any reflection of those particular businesses in the stock market.”
An upcoming fix?
The current bull market will not last forever, especially if hopes of an economic revival do not materialize as soon as expected. “It is certainly possible that we will see a drop in prices on Wall Street very soon,” Goldstein said. “There are several ways to look at it, but it could definitely be the case that we wake up and see prices start to decline. Like I said, part of what’s going on is the fact that stock prices are looking to the future, so maybe they’re looking at something bullish. but it could be that they are missing some negative signals, and maybe those negative signals will return to the market soon.”
goldstein added: “The unprecedented actions the Fed took indicate that they thought this was a time of emergency and that they needed to do whatever was necessary to keep markets active and help the economy.” That included calling for fiscal action from Congress to do more to help the economy, he noted.
Amidst all those liquidity injections, there is concern that federal debt will balloon to unmanageable proportions, Goldstein said. At the same time, “probably most people think that the times are so unprecedented, the problems are so difficult, that you should not think so much about debt but put more money to work to save the economy from falling further down.”