The New York Times recently has undertaken to explain the “disconnect” between the U.S. economy and the stock market. It observes that after a few weeks of “wild swings” the market is down a mere 9.3% this year and 13.5% from its peak, which most investors would consider a correction. Last Friday, after the release of “staggering” unemployment figures, the S&P 500 closed up 1.7%.
Conventional wisdom is that markets tend to be forward-looking and investors have already accounted for the expected drop in second-quarter activity – and the expectations are for a relatively rapid economic recovery afterward. Also, the Fed’s actions have bolstered investors’ confidence that the bottom “won’t fall out of the market.”
However, the Times focuses on “deeper reasons," including the market’s longer-term detachment from the mainstream of American life. “Wall Street has very little to do with Main Street,” said Joachim Klement, a market analyst at Liberum Capital in London,” said. “And that link is less and less important.”
Still, the market retains its grip on the collective imagination. From politicians and corporate executives to mom-and-pop investors, Americans have long relied on the stock market as a proxy for the U.S. economy for reasons that are partly historical. Its crests suggested bright days ahead, while its troughs suggested a darkening outlook.
However, the current “economic fallout” could snap the “illusions” that the logic of the market is derived, in any consistent way, from real-world events.
Part of the reason is the makeup of the market itself the Times says – and the fact that the giant companies that make up the S&P 500, for example, reflect very different circumstances than the nation’s small businesses, workers and cities and states. They are highly profitable, hold significant sums of cash and have regular access to public bond markets. They’re far more global than the typical American family firm and earn about 40 percent of their revenues from sales abroad.
In 2015, about 600,000 U.S. companies counted at least 20 employees, and only 3,600 of those – or less than 1% – were publicly listed, said Rene Stulz, a professor of finance at Ohio State University, who has studied the changing composition of publicly traded markets.
Because the financial strength of big companies makes them more likely to survive the downturn, their share prices tend to underplay the impact of widespread economic trends. In fact, market indexes like the S&P 500 are weighted to reflect the performance of the largest and most profitable companies. In recent weeks, the stocks of such companies have not only veered in the opposite direction from the outlook for the U.S. economy, but from the rest of the stock market itself.
The five largest listed companies – Microsoft, Apple, Amazon, Alphabet and Facebook – have continued to climb this year, as investors bet they will emerge in an even more dominant position after the crisis. Through the end of April, they were up roughly 10% this year, while the 495 other companies in the S&P were down 13%, according to Goldman Sachs analysts. Several of these highly valued firms, including Microsoft, Amazon and Apple are each worth more than $1 trillion and now account for one-fifth of the market value of the index, the highest level in 30 years.
“It’s very easy to get confused by looking at the S&P doing well and that being driven by a relatively small subset of firms which aren’t really affected by this virus – or actually gain from it,” Stulz said.
In addition, the mood of the market does not necessarily reflect the sentiment of a broad swath of Americans, the Times says. While more than half of American households own shares or investment funds, the overwhelming majority of those accounts are modest. Instead, stock ownership is heavily skewed to the richest segments of the population who are least likely to feel the pain of an economic downturn.
“Stock ownership among the middle class is pretty minimal,” Ed Wolff, an economist at New York University who studies the net worth of American families, told the Times. In fact, a relatively small number of wealthy families own the vast majority of the shares controlled by U.S. households. The wealthiest 10% of households own 84% of all household stock value with 40% of the value held by the top 1%.
In addition, there’s relatively little evidence that economic growth matters to the “outcome of the market at all,” according to Jay Ritter, a finance professor at the University of Florida who has studied the long-run relationship between economic growth and market returns. “In the longer run, the relationship is, empirically, it’s not there.”
None of this is a secret. So why do millions of Americans continue to think the market really is a barometer on the economy? The Times ducks the question, but it remains an important aspect of the economy and should be watched and evaluated carefully as the economy struggles to recover, Washington Insider believes.
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