Why is the stock market doing well even during the pandemic?

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Q. I can recall several serious recessions over the years when the economy suffered and the market tanked. Yet, here are in the worst economic situation in recent memory due to the pandemic, and yet the stock market is holding pretty steady. Can you explain why?
— Investor

A. If you don’t count Thursday’s downturn, stocks were holding more than steady. The S&P 500 was making new highs.

But indeed, yours is a very good question and one that is leaving many people scratching their heads.

The U.S. officially entered a recession in February, the country’s first since the Great Recession a decade ago when the financial crisis hit, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

He said the severity of the impact from the coronavirus draws comparisons to the Great Depression, the country’s worst economic downturn in the industrial era.

“Over 22 million Americans lost their jobs in April, and the 32.9% decline in second-quarter U.S. gross domestic product (GDP) was the worst quarterly reading in history,” DeFelice said. “The pandemic is causing a world of hurt for small businesses around the country, and larger companies in hard-hit industries such as airlines, travel, energy, and automotive are under severe duress.”

Yet April 2020 was one of the best months for the S&P 500 since the 1950s, he said.

“In truth, no one knows what will happen with the stock market from here,” he said. “But the recent stock market rally isn’t as strange as you may think, despite economic conditions.”

First, and perhaps most significantly, DeFelice said, the stock market is a leading indicator for the overall economy. Even in normal times, economic data looks back and the stock market looks ahead.

By definition, a recession is looking back to the last six months or longer, he said. So by the time devastating economic data makes its way to the news wire, the market has typically long been pricing it in, DeFelice said.

“Investors are betting on where the economy is going, not where it’s been, and the gains in recent months seem to signal that the worst, at least in terms of the fear factor that drove much of the initial selling, is behind us,” he said.

In the last recession, for example, the market bottomed out in March of 2009, several months before the unemployment rate peaked in October of that year, and well before GDP returned to growth in the third quarter of 2009, DeFelice said.

In other words, during a bear market or a recession, stocks begin to bounce back once a recovery becomes visible, which is before it actually starts.

Second, even if it takes more than a year to get a vaccine out, that is not terribly long for the stock market, DeFelice said.

“It is for all of us stuck at home, but in stock market time, it’s just not that long,” he said.

A company’s cash flows over the next 12 months is only a small component of the value of its stock, DeFelice said.

That’s what you’re paying for when buying a stock — the company’s future cash flows.

In this case, the future is 2021 and beyond, once the pandemic is behind us, he said.

The market is expressing confidence that the pandemic will end eventually with a vaccine, and in the interim we continue to learn more about how to prevent, treat and care for people with this disease, he said.

“Let’s face it – we know a lot more about how to handle COVID now than we did in March when it first blew up in this country,” he said. “That will continue to improve as more time goes by, and the market is reflecting all of this.”

Third, monetary and fiscal policy measures have an impact.

DeFelice said the breadth of the Federal Reserve’s response to the COVID-19 crisis is unprecedented.

“The cumulative relief packages dwarf what we saw in 2008 during the financial crisis,” he said. “They included asset purchases to boost equities when government bond yields are near zero as well as supporting the flow of commercial paper to businesses, and fiscal policies to help American workers and multiple rounds of forgivable loan programs for large and small businesses alike.”

The Federal Reserve’s actions have injected a tremendous amount of liquidity into the system, DeFelice said, “and what that has done for stock prices cannot be underestimated.”

Additionally, with savings rates near zero, stocks have been positioned as an attractive alternative for growth, he said.

Lastly, the companies that are driving the market higher are doing so for a good reason.

“They are making a ridiculous amount of money right now, many having record quarterly earnings,” DeFelice said. “Sure, the S&P 500 includes companies in sectors that are struggling – airlines, travel, cruise lines, event companies — think concerts and sporting events— big restaurant chains – all are getting killed.”

But about 40% of S&P 500 companies are classified as technology, digital media or e-commerce, he said.

Tech companies that have enabled employees to smoothly transition to working from home have thrived in this environment, as evidenced by the strong earnings reports in late July from Facebook, Apple, Amazon, Alphabet, Netflix and Zoom, for example.

He said while there are companies all over the country that are struggling to keep the doors open, but many of them are privately-owned small businesses that are not publicly traded.

Have we passed the bottom? Is another correction is coming as stock evaluations continue to soar?

DeFelice said he doesn’t have that answer, but as the economy continues to reopen and drugs move through clinical testing, we are going to find out.

“But in the interim, don’t be surprised if the market continues to move independently of bad economic news,” he said. “We always ask clients to try not to get too caught up in short term market fluctuations that are reactive to news. Unless your long-term goals and circumstances have changed, you should stick to the investment strategy you have set with your advisor. The stock market is really no place for short-term dollars in the first place.”

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This story was originally published on Sept. 4, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.