The Economy Is Down, but the Stock Market Is Up. Why?

The economy is in dire shape. Unemployment figures are shocking. Consumer spending has dropped to all-time lows. Yet, the stock market is doing well. The Dow and the S&P 500 had their best month since 1987. These diametrically opposite facts are confusing, but there are valid reasons for them.

The S&P 500 is an index of stocks of the 500 largest companies that are listed on Nasdaq or the NYSE. According to the New York Times, Microsoft, Amazon, Apple, Google (Alphabet), and Facebook are the drivers. As a large percentage of the adult population is staying home most of the time, this should come as no surprise to anyone.

Another index is the Dow Jones Industrial Average. It tracks the top 30 companies that are listed on the NYSE and Nasdaq. The DJIA traditionally performs best in April of every year. In analyzing the performance of the S&P 500 and the DJIA, it certainly appears that both are positive. The question begs. Why are they doing well when everything else seems to be in the process of collapse?

Investors tend to look forward at the economy. Investors are seeing the Federal government putting a great deal of money into the economy. The relief checks that have been sent are but an example. Investors also see plans developing that are designed to reopen parts of the economy, and they are optimistic. The whole idea of investing is to buy stocks that provide future returns. Investors expect the economy to improve. They are buying stocks now because the economy is down. They plan to benefit when the economy picks up.

The Stock Market Is Only One Slice of the Economic Pie

It is not difficult to think of the stock market as if it was the economy. Over the long term, there may be some truth to this, but rather than being a measurement of the size and strength of the economy, the stock market is more an indicator of corporate profits and the sentiment of investors.

The stock market, although reported on and discussed in minute detail, is smaller than one might think. Two-thirds of Americans work for companies that are not traded publically, and a great deal of consumer spending goes directly to small businesses or individuals, neither of which is accounted for by the stock market.

Government Backstop

Unfortunately, many American families live from one payday to the next. Many small businesses have limited cash flow reserves to survive a sudden cessation of business. Without help from the government, many individuals and small businesses would find themselves in severe financial straits.

The stock market surged upon news that the CARES act had made its way through Congress and signed into law by the President. The relief package, which is estimated to be $2.2 trillion, includes direct payments to individuals, small businesses, a bailout for airlines, and loans too big businesses adversely affected by the pandemic.

Investors seem confident that the government will do what has to be done to stabilize the economy and drive recovery. Investors are betting on the future. They are looking at where the economy is heading, not where it has been. The gains in recent weeks appear to signal that the worst is behind us.

It must be said, however, that investors are sailing in uncharted waters. The reliability of the stock market may no longer be a leading indicator of the direction of the economy.