There’s no doubt that the headlines of Wall Street and the stock market have been a rollercoaster since the pandemic began. It’s had many people wondering: what will the markets do in the future?
It’s not a bad question, but we really have no way of knowing. They usually go up, but sometimes they go down. We know that in the short term, markets are driven by fear, excitement, or envy; essentially, reactions to the mood of the moment. Over the long term markets are driven by expectations for future earnings. What the mood will be at a future date is simply unknowable. Jason Zweig, a personal finance columnist with the Wall Street Journal, sums it up well.
“…the only incontrovertible evidence that the past offers about the financial markets is that they will surprise us in the future. The corollary to this historical law is that the future will most brutally surprise those who are the most certain they understand it…So the best way to immunize yourself against being surprised is to expect to be surprised.”
But if you’re confused about the current state of the economy and the markets, you’re in good company. The last six months (feels like years, right?) have been dramatic. Earlier this year the stock market experienced the fastest selloff in history, dropping nearly 35% in just five weeks. As of August 14– 100 trading days since the market bottom– the S&P 500 had climbed 51%, while the Dow Jones Industrial Average had risen 50%, their best 100-day gains since 1933. The Nasdaq gained 62%, its biggest 100-day rally since 2000, the peak of the dot-com bubble. The Nasdaq more than erased all its loses, and the S&P 500 was just a hair beneath its all-time high.
So what is going on? How can the markets be back to near all-time highs at a time when a global pandemic has upended our lives and devastated large sectors of our economy? Oh, and don’t investors know this is an election year? There are a few factors at play here.
Differentiating between the market and the economy
The first thing to understand is that the market is not the economy. News outlets will often talk about the stock market as if it’s the only way of assessing the condition of the economy, but it’s not. Here’s why: the market is gauged using indexes, which reflect the performance of stocks in some of the country’s largest companies. Two popular market indexes are the S&P 500 and the Dow Jones Industrial Average.
As any good mathematician knows, outliers skew averages. The same is true of market indexes: strong performance of some companies in the index can disguise the poor performance of other companies. Currently, strong performance by the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Alphabet, Google’s parent company) has offset the poor performance in sectors like energy, real estate, and financials. Some of these companies are struggling, but those struggles have been masked by the outperformance of companies that are thriving (which is why we diversify our investments).
In addition, as many small- and mid-sized businesses are struggling right now, those struggles won’t necessarily get reflected in the market, but the impact to the overall economy is very real. To sum it up, the performance of companies in the S&P 500, as an example, doesn’t necessarily indicate how your favorite local restaurant down the street is faring.
The forward-looking nature of markets
Another thing to know about the stock market is that it’s forward-looking and can, therefore, be less impacted by current circumstances than you might think. For better or worse, investors have already priced in the near-term economic pain caused by the pandemic. Rising market returns tell us investors foresee a brighter future. They are likely betting on an effective vaccine or therapy which will lead to the reopening of our economies, replacing the jobs we lost, and a return to robust consumer spending.
The impact of government intervention
If you received a $1,200 stimulus check in April or if you’re refinancing your house, you already know about the third factor to consider when evaluating the stock market and the economy. Since the pandemic began, the market has been supported by dramatic and historic actions at the federal level. The Federal Reserve has lowered interest rates and Congress has passed massive stimulus packages. These actions have kept markets functioning properly and pumped trillions of dollars into the economy through a variety of channels. Without these actions we would be in a much different place right now.
So, what comes next?
What happens next is unknowable. However, we can make some assumptions. Markets love good news and hate bad surprises. We would anticipate that the market will react very favorably to an announcement of an effective treatment or vaccine, potentially paving the way to the end to this pandemic. This favorable reaction will likely be bolstered even further when some of the more than $4.6 trillion currently sitting in money markets or the record amount of cash in bank deposits comes off the sidelines and gets invested into the market. Precisely when this happens is anyone’s guess. But it probably won’t happen until investors feel comfortable that the worst is behind us and that we have a path to solving this health emergency.