Which is right, the stock market or the economy?
It is easy to see why I have been getting this question a lot recently. Over the past couple of months, the stock market has been booming. Yes, it lost 34% peak to trough as the coronavirus pandemic became a thing, but since the bottom on March 23, 2020, the S&P 500 is up a whopping 39.7% as of June 16, 2020.
We aren’t quite back up to that peak but we are within spitting distance of break-even for the year and most portfolios are up year-over-year. In all of my recent client meetings, I have found myself saying, “If you just look at the numbers, you would never know we were in a global pandemic and a period of social unrest.”
Underneath the shiny gloss of the recent market upswing, you find some pretty sobering stuff. As of June 16, 2020, the NYTimes reports more than 2.1 million infections and 116,979 dead in the U.S.; over 8 million infected and 443,423 dead worldwide. Over 21 million people in the U.S. are unemployed which equates to a rate of 13.3% out of work (for comparison, this rate peaked at 24.9% in the great depression).
To understand the disconnect between the stock market’s performance and the underlying ugliness of the economy, we have to understand a few key details about what the “stock market” is. I used the S&P 500 index above so we will stick with that. This is not just a combination of 500 stocks, it is a market-cap-weighted index. This means that the larger the company, the larger the percentage representation in the index.
When we look at the current largest positions in the S&P 500 index, it becomes pretty easy to see why the disconnect exists. The top 5 holdings as of June 16, 2020 are Microsoft, Apple, Amazon, Facebook and Alphabet (Google). Together these 5 companies (1% of the 500 in the index) make up about 20.3% of the index value.
Coincidentally, not only are those companies relatively unaffected by the pandemic, they are likely benefiting from the seismic shifts happening. Further, these companies employ far fewer people per dollar of revenue than other more traditional workplaces. With mostly knowledge workers, stay-at-home orders are not a huge impact. Simply put, these companies are not reflective of the pain points in the economy.
Ultimately, the answer to the original question is “Neither is ‘right’, they are simply measuring different things.” On a broader perspective, also remember that 98% of stock market wealth is owned by 40% of our population. Using the stock market as a true gauge of the health of the economy will always be misleading. Let the stock market be what it is, an investment tool, and don’t let it be a proxy for anything more.