4 Reasons Stocks Are Up While the Economy Is Down

Several people have asked me recently why the stock market is up so much (the S&P 500 is up over 5% on the year) when the economy is doing so poorly (there are 13 million fewer people working now than in February). So, while the movement of the stock market is unpredictable because it consists of billions of trades each day, each motivated by individual investor’s own needs and beliefs, here are 4 broad reasons for the disconnect:

1. The stock market and the economy are two entirely different things: Think of your favorite local shops and restaurants you used to frequent but that are now struggling or closed altogether. Those make up a large part of the economy, of course, but aren’t publicly traded companies on the stock market. In fact, fewer than 1% of companies with more than 20 employees are stock-owned.
2. Investors buy stocks for the future: While indicators like Gross Domestic Product (GDP) are measurements of economic activity in the past, the stock market indicates what investors think will happen in the future. For instance, when an investor buys shares of a specific company, they do so expecting that company to make money over the next 3-4 years and beyond. Even though the economy and companies’ earnings may be down now, investors expect companies to earn well in the future.
3. Investors have few alternatives other than stocks: Large investors such as University endowments and pension funds manage such large sums, they often have outsized influence on market prices. As these entities have obligations requiring them to make annual payouts, they require returns larger than what bond yields currently offer - the 10-year U.S. Treasury bond currently yields less than 0.65% annually. So, regardless whether they view the stock market as over or under-valued, they really have no choice but to take their chances there. As a result, their presence has helped buoy stocks.
4. Not all stocks are doing well: The S&P 500 performance has been led primarily by 5 companies – Apple, Amazon, Alphabet (Google), Microsoft and Facebook. Those 5 companies collectively rose 37% this year through the end of July. All the rest of the companies within the S&P 500 declined by 6% over the same time period. Those 5 have become so huge the value of their stock is 20% of the total value of the S&P 500. As a result, their good performance overshadows the collective poor performance of all the others.

          In addition, small company stocks as measured by the Russell 2000 index are down over 5% this year. And stocks outside the U.S. are down too.

What happens next? No clue. What we do know is, over the long-haul, stocks are like a yo-yo on an escalator – they go up and down in the short-term while eventually reaching a higher level.

Steve Byars, CFP®