I have received a number of questions lately regarding why the stock market is soaring when the economy is struggling during COVID-19. While some attributes may be interrelated on some level, they are not the same, nor do they all indicate the status of one another.
The stock market does not define economic health and vice versa. As we’ve seen with the recent COVID-19 pandemic, stocks are back on the rise, but many individuals - and the country as a whole - are still facing the effects of business closures, record-breaking unemployment rates and more. So why is this? Below, we outline the major differences between the stock market and the economy and why one can progress while the other tells a different story.
What Is the Economy?
The economy can be defined as “the wealth and resources of a country or region, especially in terms of the production and consumption of goods and services.”1 More specifically, one way we can understand economic activity is through real GDP (gross domestic product), which measures the value of goods and services while factoring inflation into the equation. As a result, understanding the health of the economy can be thought of in terms of the growth rate of real GDP, meaning whether or not the production of goods and services is increasing or decreasing.2
Naturally, employment may rise or fall as production and consumption increase or decrease. To produce more goods, companies and factories might hire more employees to complete such production. With more individuals employed and gathering paychecks, more people have money to spend on such goods - increasing overall consumption. Sometimes, however there may be a lag, GDP can grow but not quick enough to create more jobs for those who are unemployed. 2
What Is the Stock Market?
The stock market can be defined simply as “a stock exchange.”3 It is the buying and selling of ownership shares in a corporation.4 The stock market is comprised, therefore, of the buyers and sellers (with some buyers and sellers holding more “stock” than others) and is not necessarily indicative of every business, worker and family.
Some of the main indexes used to understand how the market is performing are the Dow Jones Industrial Average (tracking of 30 leading companies), the S&P 500 Index (500 stocks across all industries), and the Nasdaq Composite Index (a dynamic mix of 3,000 stocks across the technology, biotechnology and pharmaceutical sectors).5
The Stock Market vs. the Economy during COVID-19
The stock market and the economy can display very different pictures of “progress.” One such example is with COVID-19. In regards to the stock market, the major indexes have all surged since the market downturn in March.6 On the other hand, GDP decreased by five percent in 2020’s first quarter, and as of July 2020, the number of unemployed individuals stands at approximately 10.2%.7 Why is there such a disconnect? A few reasons below.
The economy reflects today while the stock market is forward looking. Dimensional a leading money manager states: "stock markets may react well in advance of when we observe the impact on cash flows, as expectations are embedded in prices. And the eventual direction of the stock market will depend on how the economic outcome compares to expectations." 8 In addition it has long been understood that at times, investors may be driven by emotion.9 As a result, their behavior may not be mimicking the economy’s current state nor affairs happening in real-time.
When considering the companies included in the S&P, the DJIA and the Nasdaq Composite index, the stock market isn’t representative of the U.S. economy. It is largely made up of public companies that are different than private small businesses - with different profits, liquidity, and greater access to bond markets and global positioning.
The stock market’s performance as a whole only represents a portion of the U.S. employment market. A study conducted by the National Bureau of Economic Research showed that the wealthiest 10 percent of households in the United States were in control of 84 percent of the total value of stock shares, bonds, trusts and business equity and over 80 percent of non-home real estate. This was true despite the fact that half of all households owned a portion through mutual funds, trusts or various pension accounts. Therefore, the stock market may not display an equal distribution between those who make up the economy as a whole.10 Consider other factors such as unemployment can provide a fuller depiction of the state of the economy and the financial well-being of its residents.
While the stock market may reflect some changes in the economy and vice versa, the status of one does not show the entire current portrait of the other. At times, they can tell entirely different stories, as is the case with COVID-19.
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