Why is the stock market up when the economy is in recession?

There have been a lot of articles lately about the stock market bounce while the economy is in recession. Many people are incredulous that stocks can rebound when we haven’t seen the end of the number of COVID-19 cases and we don’t know when the economy will open up again.

But stocks prices reflect what is expected in the future, not necessarily what is happening today. Eventually the economy will open again and people will get back to work.

Investors are trying to guess what that may look like. To better understand what the stock market believes will happen, we need to dig into the details.

Expectations

Of the 500 companies in the S&P 500, so far about 25% have reported earnings for the last quarter (January, February, March). Earnings are poor, since businesses started shutting down in early March.

S&P 500 earnings for the first quarter are expected to be down -15%.  This includes the results of the companies that have already reported and the estimates for the companies that will soon report.

There is a very wide range of outcomes depending on the industry. The worst economic sectors are Energy (earnings -68%), Consumer Discretionary (such as restaurants, retail, and travel have earnings down -41%), and Financials (earnings -38%).

Not all industries are negative.

Technology, Healthcare, Communication (media, gaming), and Consumer Staples (grocery stores, packaged food, pharmacies, alcohol) are expected to up modestly, from +2% to +5%.

The current quarter (April, May, June) is expected to be the worst (earnings -33%), followed by a slow recovery for the rest of the year. Overall, for the full year 2020, earnings are expected to be down nearly -20% versus last year.

It is too soon to have any confidence in what 2021 will look like, but Wall Street analysts are paid to make a forecast. The current expectation is for overall earnings to be about 4% greater than they were last year, in 2019, again with a wide deviation depending on the industry.

Until the quarantines start to lift, we won’t really know how quickly we can get back to a fully operating economy. Maybe it won’t be until we have a vaccine, maybe a combination of effective drug treatments and tracking, or maybe not until we reach herd immunity. It’s too soon to know, but hopefully we will have some visibility on the path by the end of June.

The economy will perform worse than companies’ earnings

The US economy will perform worse than stock earnings because the economy represents a much broader base. The stock market, and especially the companies that are a part of the S&P 500, are some of the most successful companies that exist. The most vulnerable businesses and employees affected by this crisis are not represented.

Small businesses employ about half of all working Americans. It ranges from dentists and lawyers, to musicians, electricians, beauticians, landscapers, and everything in between.

Before the COVID-19 crisis, the US economy was near full employment. According to the US Bureau of Labor Statistics, at the end of last year there were 165 million Americans in the labor force. 158.8 million people had jobs (farm and non-farm) and 5.8 million were unemployed.

The breakdown of labor by profession before the outbreak is as follows:

Looking through the list of occupations, there isn’t one area that is not impacted by job loss and loss of revenue. Even in healthcare, the number of non-critical treatments has been cut to make room for the critical care of COVID-19 patients. Everyone is truly in this together, but to varying degrees.

The number of unemployed reached 26 million Americans as of last week, according to current jobless claims. It may be higher because people have had trouble with the states' unemployment systems being overwhelmed. And that doesn’t include the self-employed or contract workers who aren’t eligible to file a claim.

There is no sugar-coating it. It is bad. The next question is, for how long?

What comes next?

In most parts of the country, there seems to be progress in flattening the curve of infections. Testing is still woefully inadequate, both for the active virus and for the antibodies to show someone has already had it. The ability to track outbreaks conflicts with Americans’ right to privacy. And, because of the lack of widescale testing, it seems that we still are missing basic information about the rate of infection and mortality.

So we wait. Uncertainty is not the same as risk, as this excellent article from Arthur Brooks at The Atlantic points out.

People and companies will adapt.  It will take some time for bigger trends to play out.  Meanwhile companies will do their best to conserve cash, keep employees and customers safe, and make the necessary changes to reinforce reliable supply chains, perhaps closer to home.

We will get through this and large, public companies are the best positioned to come through relatively unscathed.  If anything, this crisis reinforces the benefits they already have, such as access to capital and ability to quickly use technology to solve complex problems.  My hope is that the basic needs for all workers will be met to help create a stronger nation, a stronger citizenry, and a stronger economy.  We are in this together.

At Archer Bay Capital, we help clients better understand the markets and the economy so we can make better financial decisions together.  Contact us to discuss stocks, bonds, and our forecast for economic growth, or to schedule a consultation today.