On March 26, the U.S. Department of Labor reported that 3.28 million Americans had filed for unemployment insurance in the past week, shattering all records for weekly jobless claims since recordkeeping began in 1967. The employment reports have only worsened since then, with approximately 26.5 million jobless Americans filing for claims in the past month, and confirming that the United States has entered a very sudden, and deep recession.
The full impact of the mandated shutdowns to slow the Coronavirus pandemic won’t show up in Gross Domestic Product (GDP) figures until they are released in July, but early estimates are for an economic contraction of perhaps 8% (30-35% on an annualized basis) in the second quarter of 2020, the sharpest decline in economic activity since the Great Depression.
Despite these grim statistics, US and foreign stocks have staged a remarkable comeback from their low point on March 23, often rallying strongly on the very same days that truly awful unemployment figures were released. This market behavior seems very counterintuitive – just what is going on here?
If there is one lesson we can take away from this episode, it is that the stock market is not the economy – they are separate (but related). GDP measures the total output of various components of the economy (consumption, government spending, investment and net exports) and is akin to a national income statement. It measures what happened in the past, but ignores what might happen in the future.
In contrast, stock prices incorporate what is happening now, but also forecast everything that might happen in the future, and their associated probabilities. This includes future company earnings, economic growth, interest rates, tax rates, changes in regulations, new economic policies, and even future states of the world.
Even in “normal” times, the stock market has an uncanny ability to constantly surprise people by its ups and downs. As evidence-based investors, we know that stock market prices are volatile, and often react in ways that contradict “conventional wisdom”. While it is always risky to ascribe short-term market movements to any particular news item, it is possible that markets are rallying in April for any of the following reasons:
- When you own a stock, you are entitled to a very long stream of future cash flows. Even knocking out an entire year’s worth of dividends and earnings has a surprisingly small effect on the total value of that stock. The market may already be forecasting a recovery in earnings in 2021.
- Jobless claims appear to have peaked on April 2 and have been declining each week since. It is possible that the worst of the employment statistics is already behind us. Many states are already planning to re-open portions of their economy in the next several weeks.
- We may have already seen the peak in the growth rate of coronavirus cases and deaths. Every week brings news of potential treatments and vaccine developments. New reports of large numbers of positive but asymptomatic cases may mean that the lethality of the virus is much lower than initially thought.
- The response by the Federal Reserve and other global central banks to the pandemic has been breathtaking and swift. They ran through the entire Global Financial Crisis playbook, in scale and scope, in about three weeks. They’ve taken even bolder actions since then, and their public comments have been as striking as their actions. By flooding the system with liquidity, they may have prevented market prices from fully reflecting economic reality, and they might have success with this strategy indefinitely.
- Congress has not been shy about providing fiscal relief to affected individuals and businesses. The recently passed CARES Act, at $2.2 trillion, may nearly offset the economic contraction expected this quarter. Congress is already busy at work on “CARES Act 2”.
These (and other) countervailing measures might explain why markets haven’t always reacted in expected or predictable ways to very weak economic data – and also reveals why ‘market timing’ is so difficult. Attempting to buy and sell stocks based on the latest news is likely to be an exercise in frustration (not to mention a very costly trading strategy!) Fortunately, successful investing is not determined by your skill at “timing” the markets, but by how much time you commit to them as an investor.