Doesn't the Stock Market Know the Economy is Bad

After a precipitous drop in February and March due to the Covid-19 pandemic, the stock market has rebounded sharply, even with the recent pullback. The rise in stocks appears out of sync with an economy mired in a recession. What's up?

 Although counter-intuitive, it's important to remember that the stock market is not the economy. The stock market acts as a forward-looking mechanism based on expectations of future earnings. So while many economic indicators look bad and corporate earnings have taken a hit, it may be that investors are (naively?) optimistic about a relatively quick recovery.

The near-term outlook is opaque and reasons for concern remain, including the risk of a second wave of infections and the realization of the true cost of shutdowns. Here are some factors that may explain why the stock market has recovered nonetheless:

  • The U.S. economy was pretty healthy pre-pandemic
  • The Federal Reserve and Congress have pumped historic levels of money into the economy
  • Further government stimulus may occur
  • Bonds offer extraordinarily low interest rates, making stocks a more appealing alternative
  • When the stock market dropped in the spring, stock prices looked more attractive (i.e., buy low)
  • Investors are being very forward-looking and taking a long-term perspective beyond the current malaise
  • Markets can exhibit a crowd mentality both as to the downside and the upside
  • The hope that a vaccine will be discovered relatively soon

The market has once again shown that it can defy the obvious. Or, at least, what seems obvious.

Words of Wisdom

It's not what we don't know that hurts, it's what we know that ain't so. -- Will Rogers