The Economy is Tanking, So Why Isn’t the Stock Market?

The coronavirus pandemic has hit the economy hard, but you wouldn’t know it from the recent stock market performance. Why is there a disconnect?

Whatever it takes

Within our mandate, the Fed is ready to do whatever it takes to support the economy. Believe me, it will be enough.

Wait, did Fed Chief Jerome Powell really say that?

No, he didn’t, but the Fed’s actions seem to have said it for him.  Given the speed and force with which the Fed has moved, he might as well have uttered those words.

In actuality, it was European Central Bank President Mario Draghi who voiced this promise. In 2012, as Spain and Italy careened towards a financial cliff Draghi gave a speech (in which he said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” After a pause, he added firmly, “Believe me, it will be enough.”

In some respects, “whatever it takes” became Draghi’s legacy. No one remembers what he said during the rest of this speech. Just the thought of unlimited central bank firepower encouraged investors to step into Spanish and Italian government debt. Long story short: Another financial crisis was averted.

Despite the tanking economy, markets are fairly robust. Perhaps the Fed’s rapid response has created the same confidence for American investors. It’s so bizarre out there that it’s not even funny. Let’s take a deeper look.

The economy: Worst ever

The economy is in a free-fall. Over a six-week period, there have been 30 million first-time claims for unemployment insurance (through April 25). It’s by far the worst number of layoffs we’ve ever seen, and it is disheartening to see.

A 7.5% decline in consumer spending in March is the biggest decline on record. Industrial production slid 5.4% in March, the worst decline since the end of World War II.

Nonfarm payrolls for April will be released May 8. It will easily exceed the prior record of two million lost jobs at the end of World War II.  

Sadly, we may see an acceleration in the economic contraction this month when April’s data roll in. 

“Many standard economic statistics have yet to catch up with the reality we are experiencing,” Powell said at his end-of-April press conference. “Manufacturing output fell sharply in March and is likely to drop more rapidly (in April) as many factories have temporarily closed.”

Put simply, a health crisis has morphed into an economic crisis, with the economy contracting at depression-like speed.

“The severity of the downturn will depend on the policy actions taken at all levels of government to cushion the blow and support recovery when the crisis passes,” Powell said.

The markets: Best monthly gains since 1987

During April, the Dow Jones Industrial Average and the S&P 500 recorded their best monthly gains since 1987. It’s an incredible disconnect between the financial economy and the real economy.

One of the recurrent themes I emphasize is that bull markets (markets that go up) occur during economic expansions and bear markets (markets that go down) coincide with recessions. Expansions outlast recessions, and expansions drive the economy to higher levels. The markets follow, albeit unevenly.

The one glaring exception over the last 50 years was the 1987 market crash, which didn’t lead to an economic contraction.

The four-week, 34% decline in the S&P 500 qualifies as a bear market. Stocks imploded at a stunning pace as investors sensed the economy was running into a COVID-19 wall.

But the rally over the last month has been nothing short of astonishing given today’s dire economic environment. 

How do we explain the disconnect? 

The Fed’s “unlimited” firepower has not been enough to prevent a debilitating economic decline, but its unprecedented steps have kept an economic crisis from morphing into another financial crisis, with a massive amount of liquidity and a promise of more support aiding stocks.

Further, government stimulus of over $2.5 trillion is helping sentiment. Talk of a vaccine or treatment that would end the pandemic has been a factor. I believe investors are looking to 2021, when there is the anticipation that corporate profits will turnaround. Of course, the outlook is very uncertain. Have investors been too optimistic?

Additional government spending and support may be needed to jumpstart economic activity, as Powell alluded to in his press conference. Deficit hawks may cringe at talk of new spending and new programs haven’t been problem-free. So far, fiscal stimulus has received strong bipartisan support. 

Meanwhile, the reopening of large swaths of the economy may or may not go as planned.

Another wildcard will be consumer behavior. Prior patterns are unlikely to return to pre-crisis behavior, at least right away, and social distancing at restaurants, airlines, and industries that require person-to-person interactions could limit activity and sales.

Bottom in sight?

Yet market action suggests some type of economic bottom is in sight. Think of it like this: The level and the direction of stocks is the equivalent of the collective wisdom of millions of small and large investors.

They are not simply opinions, but real people and institutions that buy and sell equities, effectively putting their money where their mouth is, as they say. 

No one has a crystal ball. No one can tell you where stocks might be at the end of the year. There are too many unknown variables. Those who make forecasts are simply offering opinions.

I understand the uncertainty facing all of us. We are grappling with an economic and a health care crisis. It’s something none of us have ever faced. 

Okay, so what now?

Many who have unexpectedly experienced large declines in their investments or perhaps have spouses who have been laid off become paralyzed by fear and don’t know where to turn. It’s a blow to one’s self-esteem, and we understand that unexpected obstacles have been put in your path.

Job losses have skyrocketed. Some are laid off and others are furloughed, hoping to return to their jobs when the lockdown ends.

The number of first-time claims for unemployment insurance would have been inconceivable just a few weeks ago. Think about it. The jobless rate was at a 50-year low of 3.5% in February and the outlook was bright.

What should you do in the face of all of this uncertainty? Ride it out? Maybe if you have the time, but even then, you will need a plan.

The ideas I’m providing give a broad-based outline. Your situation is unique, and I am happy to assist you as you hammer out a strategy

  1. Assess your current financial situation. What are your liquid assets to help you get through these next few months? How are your investment accounts outside of the TSP allocated, and are they balanced with your TSP? What about your spouse’s retirement accounts?  How long can these sustain your lifestyle? If your spouse was laid off, will they receive a severance and paid health insurance? All of these factors and many more will play into your plan.
  2. Assess your retirement situation. Have you had retirement and cashflow projections made for you? How has this season changed those projections? What changes should you make to help ensure that you’re put back on the right track – and stay there?
  3. Come up with a realistic budget. In times of economic hardship or transitions between jobs, sometimes a budget revision becomes necessary. What kinds of things are bleeding money automatically from your bank accounts that you don’t even use? Gym memberships? Can you ask your car insurance provider to refund some premiums since you’re not using your cars as much? Might it be a good time to refinance your home given how low interest rates have fallen to?
  4. Consider your options for Social Security. Does it make sense to apply for Social Security? Should you wait instead to capture the increase in payments? 

Please recognize that you are not in this alone. These questions and others will help you formulate a financial plan as you navigate an uncertain future.

The steps above are a broad overview. Putting together a plan is critical. It’s half the battle. You may find you are in a much better position than you realized, which will relieve an enormous amount of stress, or you might uncover a major pothole that is threatening you and your family’s economic safety. Either way be proactive, not reactive. After all, it’s not just your money, it’s your future.

About the Author

Thiago Glieger, AIF®, ChFEBC℠ is a Director and advisor at RMG Advisors, a premier private wealth management firm in the Washington, DC metro area. As fiduciaries, he and his team have served federal employees for over 40 years by helping them grow, manage, and protect their wealth. Their program, The Fed Corner, produces content specifically designed to help federal employees make better financial decisions.