The S&P 500 followed one of its worst quarters ever with one of its best. After experiencing a nearly 20% drop in the first quarter, including a harrowing 34% decline from February 19th through March 23rd, the S&P 500 jumped 20%+ in the second quarter. This despite the fact that yet another wild card was dealt… civil unrest. In the midst of confronting a once-in-a-generation pandemic, the country faced social discord on a level not seen since the 1960s. It’s no stretch to say the last six months have felt more like six years. Incredibly, stocks are somehow only a hair below where they began the year. It’s as if nothing ever happened.
The performance of stocks stands in stark contrast to what many are seeing in the real economy: record unemployment claims, restaurants and bars operating at reduced capacity, movie theaters closed, smaller retailers shuttering stores, postponed vacations… the list goes on. JP Morgan tracks several “high frequency” economic data points which paint the general picture. While rebounding somewhat from March, most key metrics are still significantly off pre-pandemic levels.
Source: J.P. Morgan Guide to the Markets
So, why the disconnect between the stock market and economy? There are several possible explanations. The simplest might be that the market is anticipating a future economic recovery. Remember, the stock market is not the economy. Stocks live in the future, not the present. Investors attempt to determine where the puck is heading, not where it is or has been. It’s entirely possible investors are more optimistic about the future than what we are experiencing at the present.
An alternate explanation is that investors became overly pessimistic in March when peering into the future. Perhaps what we witnessed in the second quarter was a positive reaction to an initial, negative overreaction. While we still have a lot to learn about COVID-19, we knew next to nothing early on. Most people never considered they would ever experience a global pandemic. It’s possible the fear of the unknown initially pervaded the markets.
Then there’s the elephant in the room: unprecedented monetary and fiscal stimulus. The Federal Reserve and government, respectively, have unleashed massive programs designed to bolster the financial markets and economy. The Fed has lowered interest rates to near zero, engaged in buying corporate bonds and other assets, and created lending facilities to support businesses and municipalities. The government has literally sent checks to individuals and provided payroll support to businesses. Both the Fed and government continue messaging that more stimulus could be on the way. The Fed is one of the most powerful institutions in the world. Betting against their willingness to support markets and do “whatever it takes” – especially when the government is fully on board – is a dicey proposition at best. Fed intervention, or “the Fed put”, could be the primary reason why stocks have bounced back.
Whatever the reason, the more important question now is “where do we go from here?”. The longer-term economic impact of COVID-19 remains unclear. It’s murky enough that most S&P 500 companies, with top-shelf Chief Financial Officers, have stopped providing future earnings guidance. The questions are many. Will kids go back to school in the fall? Will businesses resume normal operations? When will people feel comfortable going to restaurants or traveling again? What about sporting events and concerts? Could we see a more severe, second wave of the virus? All of these have economic ramifications.
We said last quarter the only sure-fire solution to the COVID-19 economic dilemma remains a vaccine. But even if a vaccine is developed, how long will it take to deploy? Will everyone vaccinate? Even with a vaccine, once we finally reach the other side of this pandemic, there’s no question our lives will have permanently changed in some ways. More people will work from home. Some may move away from densely populated, urban centers. Businesses may downsize office space. College students might be more comfortable taking online courses than paying top dollar to attend a “name brand” school. We could list a hundred other potential changes in a “new normal” environment. All of these also have economic consequences, both good and bad.
The bottom line is there’s no playbook for what we all are experiencing. You could make an intelligent argument the economy is heading for rougher waters. You could just as easily contend the Fed and government will defy the forces of nature and smooth out those waters. Add-in an upcoming election cycle, social unrest, and simmering tensions with China, and there’s a lot for investors to digest. However, there is a playbook for investing. One that is time tested. Minimize costs, stay diversified, and remain disciplined. While squaring the stock market with the economy might pose a challenge, these three things always make perfect sense.