Why Is the Stock Market Going Up If the Economy is Going Down? - ToughNickel - Money
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Why Is the Stock Market Going Up If the Economy is Going Down?

Andrew is a self-educated business owner and entrepreneur with plenty of free advice (which is worth exactly what you pay for it!).

why-is-the-stock-market-going-up-if-the-economy-is-going-down

So, What Gives?

Here in the age of the covid-19 pandemic, the United States GDP has dropped by nearly a third during the second quarter. Unemployment levels are off the charts, higher than at any time in nearly a century, and corporate earnings prospects are dismal for a record number of businesses. People in many states can't go out to buy stuff or spend money on eating out and other services like movies or live music, sports have either been canceled or have taken an enormous hit to their bottom line, and everything is much slower now. On the flip side, the NASDAQ smashed through record highs, and the S&P 500 and Dow Jones Industrial Average have approached prior highs, experiencing its best quarter in more than 20 years. So, what gives?

Lollapalooza Effects

That's a good question. There are a few factors that are converging together, sort of a lollapalooza for the stock market. The first thing to understand, and the most important for laying out the groundwork, is that the economy isn't the stock market. While the economy represents how things are going right now (all of the collective businesses and individuals have sold X and made Y money), the stock market is forward-looking. It seeks to anticipate how things will be in the future. Investors look to make a return ten years from now in some cases (or even 20 or 30 years), whereas traders are much more short term- but investors play an enormous role, since they are looking to the far future. So, if I were to buy your corner convenience store from you today, I would have to consider what it might make over the next ten years, not what it will make over the next few months (likely zero for the next few months after expenses if we're still in the middle of a pandemic!). That's even more so true for bigger businesses, like say General Motors. GM is a huge company with lots of businesses under its mantle, but if you buy GM stock, you buy all of those huge businesses. Part of it is cars. Will cars sell much over the next year or two? Maybe, maybe not. Will cars sell over the next 10 or 20 years? I would bet yes, definitely, and the business has plenty of time to adapt. So, that's the first thing to keep in mind- investors look to the future to determine what is going to happen, and that implies a much longer time line than just covid. And, although the market is up, other than in a few sectors, it is still below its pre-covid levels in many places (more on the exceptions later).


why-is-the-stock-market-going-up-if-the-economy-is-going-down

What Do People Mean When they Say "The Stock Market"?

The answer isn't exactly as simple as it might seem, since there are different markets, but in a nutshell, the stock market is where tiny pieces of businesses (stocks) are bought and sold, mainly from individual and institutional investors and traders. The Dow Jones Industrial Average is probably the one most people are most familiar with. When people talk about the stock market crash of 1929 (Black Tuesday), they're usually citing statistics from the Dow, like this chart:

The DJIA is the 30 largest US companies by market capitalization (what you could buy the whole company for it if was all for sale, according to the share price). So, on that basis, it's maybe not the greatest indicator of how the US is doing overall with regard to business future. Many say the S&P 500 is much better for that. However, the S&P includes companies that aren't in the US- although most are, especially by percentage (Apple, Microsoft, Amazon, etc - those are monstrously large companies, many times larger than many of the other companies combined).

There's another index that's really widely followed by US investors, too - the NASDAQ. This one's different from either of the other two in that it's mainly technology-based companies (although all of the bigger tech companies will also be in both the Dow and S&P 500). NASDAQ is the one index of these three that has continued to go up during covid, and given that bit of information (that it's technology company based), you can probably see why.

So, the biggest companies in the S&P 500 are tech based, like Amazon, and it's pretty easy to see why a company like Amazon is going to do really well right now. To add to that, index funds invest in the S&P itself, with market-cap weighted funds (meaning if Amazon is 10% of the S&P, they'll put 10% of the fund into Amazon). So, that kind of magnifies the effect of the tech companies' success when you see the S&P 500 going up and up, even approaching pre-covid levels. Part of the reason is because the companies involved are, in fact, doing really really well right now.

Money Printer Go BRRRR

There's another really compelling reason that stock averages are up while the economy is suffering. First, the Fed has printed trillions of dollars (I think this is pretty big news everywhere, and they'll call it things like "quantitative easing" or "economic stimulus", but basically, these are dollars printed out of thin air that didn't exist before). So, if I have one Bo Jackson rookie card, it's worth a LOT to me. if I have a hundred Bo Jackson rookie cards, they might not each be worth quite so much. Same goes with dollars in the overall economy. This means that a company is worth more dollars, so that's also part of the reason you're seeing many stock prices go up while the economy is lagging: because dollars are worth less now, so investors will trade more dollars for a share of Amazon than they would have before. This is a sneaky form of inflation that people don't really normally think of when they think of inflation. They think of milk or gasoline.

TINA: There Is No Alternative

Another consideration: if you're trying to preserve your wealth, where else are you going to put your money? You know cash is going to be worth less in the future due to inflation, so you'd want to put it somewhere that earns more cash over time. One place might be an investment that's considered safe, like a Treasury bill, but the problem is that the Fed has lowered interest rates so much (thanks to bullying by Trump over the years, and also recently, in an attempt to stimulate the economy), that Treasury yields are almost zero. In other words, the "safe" bets are the same as holding cash, meaning inflation will just eat your cash away. So, hiding it under your mattress isn't going to work, and buying Treasurys isn't going to work. That's why we are seeing so much money dumped into three areas, and why all three price categories are skyrocketing right now:

1. Stocks

2. Real estate (especially homes - understandable why commercial real estate prices aren't skyrocketing, but homes are)

3. Precious metals

The Boredom

Finally, there's something to be said for the excitement of the stock market. Some folks don't like much risk, and would prefer to stay at home and watch Netflix during their down time (and hey, if you're working from home nowadays, what even is the difference between "down" and "not down" time? do days matter?). However, there's an entirely different type of person who is much less risk-averse. It's not that these folks have been investing in stocks the entire time, necessarily. Many would have been doing things like gambling on sports or in casinos, a pastime that can seem like it's from another lifetime. Still other people are just curious, and have the opportunity to invest for the first time since they've gotten a monetary stimulus, or aren't spending this money on entertainment.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

Comments

Andrew Smith (author) from Richmond, VA on August 26, 2020:

Thanks, Drew! Appreciate you stopping by.

Drew Agravante from Philippines, Currently in Qatar on August 15, 2020:

Thanks for the tips. Here I was thinking was the heck is happening in US stock markets. So that was it. I learned quite a lot.

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