As our government works to contain the coronavirus pandemic and its economic impact, many analysts are trying to predict how the U.S. stock market will behave. If you’ve been following financial news lately, you may have encountered a common (and important) phrase: The stock market is not the economy.
What does that mean? In simplest terms, stock prices do not reflect the overall health of the economy.
Consider that while the U.S. economy showed some signs of improvement in June and July, two major economic indicators continued to point to trouble: the unemployment rate and U.S. economic growth (as measured by gross domestic product or GDP).
The unemployment rate, which remains above 10%, does not tell a particularly optimistic story. In fact, for 19 consecutive weeks through the end of July, Americans filed more than one million new unemployment claims, breaking all previous records for the reading since it began in the 1950s.
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Meanwhile, economic growth in the U.S. suffered its worst slump on record in the second quarter, which is four times the decline seen during the worst part of the global financial crisis of 2007-2008.
Despite that, the stocks of the largest companies in the U.S. (as measured by the S&P 500 Index) turned in their best second-quarter performance in more than 20 years.
How can that be?
Many folks mistakenly believe that the overall health of the economy correlates to stock-market performance. Instead, there is a big disconnect between the two.
First, stock prices reflect future expectations. When investors buy stocks, they are looking beyond current conditions and are betting on what they think will happen in the future. For example, many are optimistic about the possibility of widespread distribution of a vaccine for COVID-19 in 2021. Still, it’s important to remember that such confidence doesn’t influence present economic conditions, such as consumer spending or unemployment.
Second, most stock indexes reflect the performance of the largest and (typically) most profitable companies—many of which have a major global footprint. The largest corporations in the technology, communication services and healthcare sectors all benefited from COVID-19’s spread for various reasons. The companies in these industries accounted for nearly half of the value of the S&P 500 Index at the end of July. But they also represent a much smaller percentage of U.S. economic activity.
The health of our economy is largely driven by the small- to medium-sized businesses on Main Street, such as local restaurants, bars, and mom-and-pop stores. While these smaller enterprises may not be publicly traded on a stock exchange, they do account for nearly 50% of U.S. economic activity. As we unfortunately know, they were the least prepared for shutdowns and many did not survive.
So what’s the outlook for U.S. stocks?
Many experts think U.S. stocks still have room to run. That said, it may be worth looking beyond the stocks in the S&P 500 Index because small- to mid-sized U.S. stocks—and those companies beyond the technology sector—are priced at a bargain. Also, consider investigating stocks outside of the U.S., as international stocks may outperform domestic stocks, especially if the U.S. dollar weakens compared to other currencies for a prolonged time.
It may be years, rather than months, before things return to more normal conditions. Your financial plan should be built with this in mind. If you’d like to do a check-up on your portfolio, click here to schedule a no-cost meeting with one of our financial advisors.