The stock market and the economy are NOT the same thing
In April, the Dow Jones Industrial Average staged its best two-week performance since the 1930s, a dramatic rebound that illustrates a bizarre reality about the stock market these days: markets can go up even when the economic news is terrible.
Dramatic rallies are a sign that many investors are positioning themselves for the United States to make a speedy recovery when the coronavirus crisis eases. Investors have been encouraged by states getting back to business, along with hopes that a treatment for COVID-19 could be near.
Many investors agree that the most important driver of these sorts of rebounds has been the Federal Reserve’s massive stimulus plan, combined with the efforts of the U.S. government, which sent a signal that both were willing to step in like never before to bolster the economy. U.S. stocks bottomed on March 23, after the Fed cut rates to zero.
The central bank unleashed a massive program to buy U.S. government bonds and mortgage-backed securities, while Congress has already passed the largest relief package in U.S. history, with more help expected soon.
For most investors, it’s not a good idea to bet against stocks when the Fed steps in. The stimulus spurred a fear of missing out among many investors with cash on the sidelines; they put their money to work in the market, buying the dips.
The economy, on the other hand, has bit hit with a ton of negative headlines. From post-War high unemployment numbers to cratering retail sales, all signs point to a challenging time ahead for the U.S. But even as the data gets more negative, investors are buying stocks. Why?
In part, analysts are looking past this year’s lower earnings expectations for companies and forecasting profit growth next year. That’s a plus for stocks.
Another part has to do with the fact that the market is heavily weighted toward a few big tech names, many of which are poised to benefit from less competition and an increasingly digital economy. Those names are doing well, putting a floor under any losses by the broader market. That, plus the fact that the Main Street stores taking the biggest hit from the pandemic aren’t listed on major exchanges, helps to explain the market’s upward trajectory.
But probably the biggest reason investors have seen such a split between economic and market performance is the Federal Reserve, which is throwing everything, including the kitchen sink, at the problem in order to calm the financial system. There’s a phrase known in the investment community that applies in this case: Don’t fight the Fed. In other words, when the Federal Reserve is intent on boosting asset prices by creating a tsunami of liquidity and cheap money, ride those waves in the same direction. Don’t swim against the current.
Instead hold your nose and buy.