U.S. Equity markets finally took a breather this week, modestly pulling back following an incredible rebound off the March 23rd low. The S&P500 is now down about 15% from its February high, while U.S. small cap stocks are down about 26% and international equities down about 22% from their highs. Most of this week’s pullback took place in the first half of the week, but U.S. equities fought back the last two trading sessions with strong closes after opening both days in the red. Most of the focus as of late has been around how and when states and counties will begin to reopen their economies in the face of coronavirus uncertainty and mixed messages from the White House and health experts alike. Unemployment numbers continue to rise at a staggering pace with about one in five American workers filing for unemployment since mid-March. Awful economic data continues to mount from coronavirus related impact while the market as a whole has been relatively resilient, baffling many investors.
S&P 500: 2863.70 (-2.26%)
FTSE All-World ex-US (VEU): (-2.52%)
US 10 Year Treasury Yield: 0.64 (-0.05)
Gold: $1,742.33 (+2.36%)
EUR/USD: 1.0820 (-0.19%)
- Monday – Lawmakers in Washington are working on the latest stimulus bill aimed at supporting states and counties affected by the coronavirus pandemic.
- Tuesday – Twitter announced a new policy that will allow employees to work from home indefinitely.
- Tuesday –Uber Technologies Inc. made an offer to acquire Grubhub Inc. as demand for food delivery spikes during the pandemic.
- Wednesday – Federal Reserve Chairman Jerome Powell made the statement that negative interest rates in the U.S. are not being considered.
- Thursday – The Jobless claims report for last week came int at 2.98 million bringing the total jobless claims to a total of 36.5 since the coronavirus shutdowns began in mid-March.
- Friday – The Commerce Department announced it would require a license to supply U.S. technology to be used by the Chinese tech company Huawei Technologies.
Since the March 23rd low the S&P500 has rebound about 28% in less than two months while the coronavirus has devastated the real economy. You have likely heard one explanation for the disconnect is that the stock market is not the same thing as the economy and that is true. There are also many other factors at play right now though like massive stimulus, record low interest rates, and the fact that economic data is backward looking, and markets are forward looking. Let’s focus on this question though.
What is the difference between the stock market and the real economy?
At the most basic level, the economy is the production and consumption of goods and services. It encompasses all individuals, companies, and the government. The stock market however is an exchange where the buying, selling and issuance of shares in publicly held companies takes place. It facilitates the ownership of these publicly traded companies.
Small businesses (independent businesses having fewer than 500 employees) are known to be the lifeblood of the U.S. economy, but do not represent the stock market. Per data from the U.S. Small Business Administration, small businesses make up about half of private sector employment and 44% of U.S. economic activity. They are a whopping 99.7% of U.S. employer firms and create two-thirds of net new jobs. Less than about one in three Americans work for a publicly traded company. That means the U.S. stock market only represents a portion of U.S. employment and does not entirely reflect how economic gains are distributed throughout the economy. The composition of the stock market is also different from the real economy. We see this in the capitalization weighting of major indexes that heavily weigh toward a few companies and sectors. Right now, the largest 5 companies, mostly mega growth technology companies, make up 20% of the S&P500 and have been holding up much better than the majority of other companies.
It is generally understood that day to day market swings do not reflect what is going on in the true economy, although it may feel like it should. There are some fundamental differences between the two which can be exacerbated in short time periods, but over the long-run the stock market and the economy tend to have a stronger correlation.