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Why Is The Stock Market Increasing While The Economy Contracts?

Many factors are at work in the market's speedy recovery.

A lot is going on the economy these days, but one thing that has been fairly consistent, at least since the end of March, is that the stock market has been clawing its way back toward the pre-pandemic highs. With much economic news that is decidedly mixed, why is the stock market doing so well?

Back in February, the Dow Jones Industrial Average was flirting with the $30,000 level. A few short weeks later, the Dow bottomed out 18,591 on March 23. Now, despite the pandemic, the ravaged economy, and racial unrest, the Dow has regained much of that lost ground. Trading has often been turbulent, but the Dow closed yesterday (today is a market holiday) at 25,827, which is only about 12 percent below its high for the year and up 92.39 for the week.

As with many things, there is no single answer for why the stock market is booming while the rest of the economy is hurting. One immediate factor is that this week’s jobs report was better than expected, which encouraged investors.

Job losses in March hit record highs but the return to work has also been historically swift. The June jobs report showed that 4.8 million jobs were created last month, which was much better than expected. The unemployment rate fell by 2.2 points to 11.1 percent. Despite the fact that the unemployment rate is 7.6 points higher than February, the June numbers are an improvement over the depths of March and April.

There are other factors at work as well. Not all companies are equally vulnerable to the pandemic and the associated economic decline. Travel companies, such as hotels and airlines, have suffered while other types of companies are better able to weather the storm. As with other areas of life, size also matters in pandemic economics.

“Large companies have fallen much less than smaller companies. It is likely that as a result of this crisis the strong will get stronger … and so the stock market is reflecting that in its relative valuation,” Peter Orszag, Financial Advisory CEO at Lazard and former OMB director under Obama, told CNBC in May.

Others point to the fact that the computers that do much of the trading are not as emotional as their human counterparts. News reports of rioting across the country can make individual investors tuck tail but not the algorithms at the big trading houses.

“The market always seems heartless, without any emotion, without caring, without empathy. But that’s the nature of the market,” Quincy Krosby, chief market strategist at Prudential Financial, said on CNBC. “The algorithms almost certainly have no shred of empathy. They’re not supposed to.”

Still, sometimes news does trigger a run on the markets. Often, however, this is economic news such as jobs reports or geopolitical events such as attacks on oil facilities in the Middle East.

An additional factor this year was the government’s economic impact payments. These “stimulus checks” started going out in April as part of the CARES Act. With few places open to spend the money, many consumers put the windfall into the stock market.

An analysis of bank transfers in March and April by software and data company Envestnet Yodlee found that stock trading ranked third behind increasing savings and cash withdrawals as a use for the government funds. The analysis, which was reported in CNBC, found that the government payments increased spending by 81 percent and that trading stocks, which include contributions to 401k and IRA plans, was among the most common uses for the funds at nearly every income level.

One effect of pouring so much money into the stock market would be increased demand. And, as any ECON 101 student can tell you, when demand increases, so do prices.

Even though the stock market has proven resilient so far, there are warning signs. Much economic data, such as the June jobs report, is backward-looking. Even though jobs were created in May and June as much of the country reopened, the report does not reflect the potential layoffs that may be occurring as I write this due to the resurgence of the virus in many areas around the country.

The pandemic is not over yet. Coronavirus will not cease to affect the economy until either the disease runs its course or a viable treatment and/or vaccine is developed. As a result of COVID flare-ups, there will be economic ups and downs for the foreseeable future, but, over the long term, the stock market has proven to be a good investment. That is most likely true in 2020 as well.

If you would like to continue the discussion on social media, you can visit David Thornton’s Facebook page or follow him on Twitter.

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