Many investors are puzzled by the apparent disconnect between the U.S. stock market and an economy that remains in recession with an unemployment rate last seen in the Great Depression. We continue to believe that there will be volatility ahead and an opportunity to be more aggressive with equities in the coming weeks and months. That said, while it is difficult to have confidence in the market in such challenging times there are several reasons that support a resilient market.

First, the market is a discounting mechanism. In other words, the market reflects future economic activity in today’s prices. The market is efficient and has a strong track record of sniffing out economic developments long before they become apparent in the data. After all, the stock market is included in the Organization of Economic Cooperation and Development’s well-followed composite of leading economic indicators. These indicators are a basket of data points that tend to predict future economic activity. The market will discount both future improvements and deteriorations in the economy. Historically, the market tends to start rallying about six months before the official end of a recession. Even more, these rallies can be significant. Since World War II, stocks are up by an average of 25 percent from the low point before a new economic recovery even begins. As can be seen in the chart below, during the Great Financial Crisis, the S&P 500 bottomed out an entire year before employment began to rise.

With unemployment at multigenerational highs and second-wave fears beginning to emerge, how could the market possibly signal the economy is going to get better? The answer is fiscal and monetary stimulus. The magnitude of stimulus is entirely unprecedented. Not only in size but also in speed. Fiscal stimulus of $2.5 trillion and counting is three times the size of the stimulus that brought an end to the financial crisis. This was signed into law about a week after the national shut down. A recent study posted by the Wall Street Journal found that 64 percent of those collecting enhanced unemployment from the CARES act are making more without a job than they did prior to the crisis. The Fed is conducting limitless asset purchases, providing support to market prices, adding liquidity and stabilizing the banking system.

Another reason the market and economy appear disconnected is that they have an increasingly different composition. The market is dominated by internet, technology and healthcare companies whereas the U.S. economy is driven by consumer spending. Microsoft, Amazon, Apple, Google and Facebook account for more than 21 percent of the S&P 500. On the other hand, the sales of these companies amount to just 2 percent of U.S. GDP. Despite the global pandemic, their combined sales are expected to rise a combined $99 billion dollars. Said differently, the largest components of the stock market have also been the most resilient in the downturn. The same cannot be said for the economy.

There is no denying that the market is optically expensive and has come a long way in a very short period of time and to be clear, we believe there will be better opportunities to add risk to portfolios in the coming months. However, there are also logical reasons to support the apparent dichotomy between stock prices and a very challenged economy. First, the market reflects the economy of the future, not the present. Next, the government has injected unprecedented stimulus to support consumers and businesses. Lastly, the market composition is very different from the U.S. economy.

Week in Review and our Takeaways:

• Today’s market price reflects a prediction of future economic activity

• We believe there will be more opportunity to add risk to portfolios in the coming weeks and months

• The S&P 500 has a much different composition than the U.S. economy

Disclosures