Almost every casual conversation I have about the economy turns to the stunning recovery of the stock market. From investment professional to anxious observer, few can reconcile a Great Depression level of unemployment and GDP declines with the resurrection of stock markets that has taken place since the crash of March 2020.
Now, I don’t wish to pretend I can forecast stocks or fully explain why they’ve recovered. If I could predict the stock market 60% of the time, I’d be among the richest men in the world in just a few weeks. What I can do is offer some reasonable causes for the wild swings and nearly full recovery we’ve experienced over the past six months.
To begin, I’ll have to share some too infrequently spoken truths about stock markets. The first is simply that stock markets exist to match household savings with investment opportunities. This is what all financial services do, and stock markets are especially good at it.
For all the convenient critiques of Wall Street as a place for rich people, most American families own stock. If you have any retirement fund, at any time in your life, you are a Wall Street investor. You may pick stocks yourself or, like my family, let a fund manager pick them. Either way, you are a capitalist. That is news to celebrate, because the future will require the economic growth that only capitalism can deliver.
The stock market is important for other reasons. Many nonprofits and nearly all philanthropic organizations rely upon stock returns. That means everything from youth sports to anti-poverty programs to scholarships rely on the growth of wealth delivered by stocks. There is no good alternative, and we should be enormously thankful that we enjoy well-functioning markets.
With stock markets serving this important societal service, it would be too much to ask that they also be good measures of overall economic performance. All we can expect is that prices of stocks will signal where the best investment options lie. That is profoundly important, and gives us some insight into why stock prices recovered from the March crash.
In the wake of COVID-19, the Federal Reserve cut interest rates, flooded financial markets with cash by purchasing bonds and bought private sector debt. This is consistent with its legal mandate set in 1947 to keep inflation and unemployment low. The goal of these policies was to push money into more productive activities, thus reviving the economy.
So, Fed policies meant that bank deposits had very low returns, causing some households to move money to stocks. It also pushed bond yields negative after adjusting for inflation. Bond markets are where governments go to borrow cheaply, and pushing them into negative territory caused some investors to move to stocks.
These policies are far from perfect, but they tend to restore confidence in the economy, and explain at least part of the stock market recovery. In other words, stock markets recovered because they offered the least bad haven for those with savings.
Another explanation for the stock market resurgence is the limited nature of early economic damage from COVID-19. Some corporations listed in stock markets faced early losses, such as Disney and United Airlines. But, most of the economic damage of COVID-19 has fallen on smaller companies, such as independent restaurants and bars, which don’t show up on the stock market. Eventually, lost employment will put major downward pressure on stock prices. But we are just six months into a multi-year downturn, and the fullness of this downturn is ahead of us, not behind us.
The stock market isn’t just affected by the absence of small firms on its listing. The shifts in household and business consumption that accompanied the early stages of the pandemic benefited some of the largest firms on the listing. Large technology firms, such as Apple and Google, profited from us working at home as we bought new equipment, software and online services. Amazon’s stock prices are up by 40% since the start of the pandemic.
Stock market indices are not linear combinations of listed firms; they are weighted by firm value, so the big firms that did best in the pandemic swamp the smaller firms, such as airlines or hotels. Even Disney, which saw its theme parks close, recovered as its streaming services replaced its lost profits.
Michael J. Hicks, Ph.D., is director of the Center for Business and Economic Research and a professor of economics at Ball State University. His column appears in Indiana newspapers. Send comments to [email protected].
