Financial markets were the topic du jour (week) in Macro and it seemed like a good time to think about the stock market. We've all heard "stock markets are not the real economy" but the dramatic divergence between stock market numbers and the pandemic real economy prodded me to think more about this connection. Or is it a disconnection? That is the question...
This WSJ article-- Why Did Stock Markets Rebound From Covid in Record Time? Here Are Five Reasons provided a starting point to think about this question. The stock market has recovered in record time following the crash at the onset of the pandemic. The main reasons behind are i) fiscal and monetary stimulus: Both sets of policy makers took massive actions early on prop up the economy. While the fiscal stimulus in the form extra unemployment benefits and the PPP has run out, the Fed is indefinitely injecting liquidity into markets by purchasing assets, ii) expectations of a strong recovery (still a lot shapes out there-- v-shaped recovery, square root shaped, w-shaped) iii) dominance of tech stocks-- the stock market is incredibly concentrated. For example just six stocks: Apple, Amazon, Microsoft, Facebook, Google and Tesla now make up half of the Nasdaq 100. Just five stocks Apple, Amazon, Microsoft, Alphabet and Facebook make up almost a quarter of the S&P 500. So when these prices rise, so do the indices. iv) Robinhooders! These are small investors and day traders (many using the Robinhood app) to plunge into the world of game-ified trading while hanging out at home and v) momentum trading which is investors chasing trends and rising the wave of stocks on the way up. Tesla, whose stock +400% exemplifies this.
So is the stock market "disconnected from the economy"? Heather Boushey, in this WaPo op-ed, quotes ex-Fed Chair Janet Yellen, "The stock market isn’t the economy. The economy is production and jobs, and there are shortfalls in virtually every sector."
So yes there would appear to be a disconnect if we were talking about the entire stock market. In fact, the dramatic rises we have seen are not across the whole market, but only in specific indices. Indices that put a lot of weight in the big tech companies.
This morning, Nathan Tankus in his superb column "Notes on the Crisis" made this point very well. He plots the YTD returns for the companies listed on the S&P 500 index against their sales growth.
This seems to show much more matching between sales and returns than our stock market sceptics would have us believe. Companies that have seen sales collapse have seen hugely negative returns. Companies that have seen big jumps in sales, have seen big returns. Companies that are treading water in sales are also treading water in stock returns. It’s hard to see from this data any reason to think the stock market is particularly disconnected from the ‘real’ shape of things.
People are buying a lot of goods and services from Amazon, Netflix, Alphabet/Google, and that is showing up in their stock returns. Nothing to be surprised about. So the rise in the S&P 500 and Nasdaq is certainly tied to the performance of companies that are heavily weighted in them.
So to answer the question, "Are the big-cap stock market indices disconnected from the portion of the real economy that they represent?"
No, they are not.
But closing the discussion here would be incomplete. What story does the rest of the stock market tell? Beyond the frothy top, the rest of the market tells a more sobering story. The Russell 2000, an index of "small cap" companies, those with assets less than $2 billion, is down almost 15% since the beginning of the year. In fact, Apple shares have skyrocketed 57% in 2020 and were recently worth more than all of the small companies in the Russell 2000 index combined. Sectors that have suffered major blows like airlines, hospitality and department stores are not a very big part of the stock market. Look around the neighbors, the small businesses are the ones doing poorly but they are not listed in the stock market. Barry Ritholtz, another finance commentator I enjoy reading tells Yahoo!:
"Apple, Google and Facebook get more than half of their revenue from overseas. “Why is that important,” he asks? “[Because] the U.S. is 4% of the world population and has a quarter of infections. The rest of the world is managing lockdown much better, so if half of your business comes from overseas you’re doing well.”
So to get a better idea of the condition of a (big) businesses in the economy, we have to look at the stock market broadly.
What about the condition of households in the economy? Most directly and immediately, the stock market tells us about the condition of households who hold shares in businesses listed on the stock market. Who holds shares, that is, who's wealth is growing?
According to Federal Reserve data, the top 1 percent of U.S. households (by wealth) own over 50% percent of equities and mutual fund shares, and the top 10 percent own 87 percent — which leaves workers in the bottom 90 percent owning just 13 percent.
