In 2020 the most common question clients asked me is how can the market keep increasing when the pandemic has been so devastating for businesses and the economy?
Sometimes hard to fathom, but the stock market is not a bellwether for the economy, and they do not move in tandem with each other.
Stocks are driven by expectations about future corporate profits, both how high they will be and how much that will be worth in today's dollars. For the former, one needs to forecast how strong the economy will be. For the latter, one needs to forecast future interest rates.
- The higher interest rates are, the less a dollar earned in the future will be worth.
- The lower interest rates are, the more investors will be tempted to pull forward future earnings into today's prices.
So, if the outlook for future earnings improves, stock prices will rise even if the underlying economic conditions do not improve. Here are some examples:
- You may have noticed that the stock market surged when there was good vaccine news. This is in anticipation of the pent-up demand expected when things return to normal.
- When there is a Federal Reserve meeting, the news of interest rate policy generally effects the market, especially if the news comes as a surprise.
- Another reason is the change in U.S. businesses represented by the stock market. There is an increasing disconnect between the stock market and US employment because many emerging technology companies have comparatively few employees.
Fifty years ago, large US manufacturers employed the largest number of workers. Today manufacturing accounts for less than 20% of all employment. Now as the economy is becoming more service, healthcare and education-oriented, the stock market becomes less representative of total current economic activity. Service firms, including, professional business services, leisure, and hospitality, have grown more than 200% since the early 70s.1 These types of firms are less likely to be publicly listed. The stock market measures how the most valuable public companies are doing but it doesn’t necessarily reflect the smaller, private companies where an increasing share of Americans actually work.
It is easy to become rattled by the news and rhetoric that we hear. So, when you are asking yourself how the market can still advance, just remember that the stock market is not a reflection of the financial health of the country as a whole.
As always, please reach out if you would like to discuss your personal financial situation.
1. Financial Advisor Mag., Peter R. Orszag “Link Between Equities And Economy Weakens,” Dec, 2020