Market behavior puzzling in face of economic turmoil

The stock market has been going strong for the past few months, even if the rest of the economy has not been doing so well.

In a world turned upside down by high unemployment, civil unrest and the outbreak of a deadly virus, the market has been brushing it off and continuing to push higher. Thursday’s almost 6% plunge by the S&P 500 may cause investors to reexamine the trend, but so far, the market has had a mind of its own.

“It’s remarkable how the stock market totally ignores the chaos around us and keeps looking ahead,” said David Root, CEO of Downtown-based financial advising firm DBR & Co.

Wall Street was caught offguard earlier this year by the speed in which all the major U.S. stock market indices plunged — dropping about 34% from their all-time highs in mid-February to the low point on March 23 amid fears of COVID-19 and the impact its spread would have on the global economy.

That crash seems like a distant memory now. The rebound for stocks also has been notable for how rapidly it occurred. The tech-heavy Nasdaq stock index made a new all-time high this week, and — despite Thursday’s hit — the S&P 500 index is just 12% to 14% off its all-time high.

While it’s not unusual for the stock market to move in a different direction from the general economy, the current disconnect between stock prices and the economic data that tracks what’s happening in the real world has never been so severe.

Is there a logical reason for the disparity?

“The market is not some mindless monster that reacts emotionally in mass hysteria. Rather, it seeks to find what will add to profitability, and right now that’s what it’s saying,” said Robert Fragasso, chairman and CEO of Downtown-based Fragasso Financial Advisors.

Because of the coronavirus pandemic and the changes that will be required in how businesses operate, he noted, companies will have to do things differently in the future. The stock market anticipates some will be more profitable because of that.

Two examples are auto rental companies and hotels, which

have experienced greatly diminished customer use. Their fates depend on what they do with that capacity. If they do nothing, it could put them under. But, Mr. Fragrasso said, if they create new uses and control their expenses, it could lead them back to profitability.

“Even though we are in the middle of a pandemic and civil unrest and record unemployment, the market sees a basis for optimism,” he said. “It doesn’t anticipate an immediate recovery, but it’s reacting to a gathering momentum toward a return to a stronger economy.”

Forward-looking indicator

Only about half of American households own stocks, and those that do mostly hold it in retirement accounts.

The Federal Reserve’s Survey of Consumer Finances most recent report released in 2016 found just 52% of U.S. families own any stock whatsoever and 87.8% of those who held stock did so in a taxdeferred retirement account like an IRA or a 401(k). Only 26.9% owned individual shares of stock.

“While stock ownership is concentrated in the top 20% of the population, what happens in the stock market influences the mood of the rest of the population,” Mr. Fragasso said.

The market is considered to be a forward-looking economic indicator. It is responding to what investors anticipate to be a much improved economic environment going forward. In the meantime, the economy is being subsidized by the liquidity and fiscal largess provided by the federal government.

The Federal Reserve and Congress have pumped money into the economy and propped up markets to mute the effects of the COVID-19 crisis. For now, it’s calming investors’ nerves.

Mark Luschini, chief investment officer for Downtown-based Janney Montgomery Scott, said the magnitude of the stock market rally speaks to the actions taken by the Federal Reserve Bank and the fiscal packages passed by federal lawmakers.

“While we’ve seen many times in history after a waterfall decline — like we had in March — deeply oversold conditions, you tend to get a violent rebound to follow,” Mr.

Luschini said.

The gains made in the past 2½ months dwarf price movements seen in previous post-rally crashes.

“We are well over 45% [increase] from the March 23 low point,” Mr. Luschini said, speaking before Thursday’s drop. “Typically, in these rebounds, stocks have risen 25% or 30%.”

Making a bet

Mr. Root at DBR & Co. said the market doesn’t recognize much of a difference between where the economy is today — thanks to all the new liquidity in the system — and where it was in late February, when the stock prices were at an all-time high and Americans were just getting familiar with the term coronavirus.

He said that is because the federal government has softened the blow for many workers who lost their jobs during the COVID-19 shutdowns by doing a virtual dollar-fordollar replacement of the income they lost. They’ve gotten stimulus checks and an additional $600 a week in unemployment benefits on top of what they get from their state.

Meanwhile, the Federal Reserve is making numerous asset purchases to provide relief to individuals and companies.

“If you look ahead six to nine months, the market is making a bet that the economy will be in a better place than than today,” Mr. Root said.

Another explanation for the surge in stock prices comes from Jim Meredith, executive vice president at the Downtown-based Hefren-Tillotson wealth management firm.

Although interest rates are still very low, Mr. Meredith said, the yield curve for bonds is rising, and that is usually a good barometer for better days ahead. The 10-year Treasury bond is yielding 0.81% compared to a yield of 0.59% in March, which is a 37% increase. The yield on 30-year U.S. Treasury bonds is double the 10-year Treasury yield.

“The yield curve is an extremely accurate forecaster of the future direction of the economy,” he said.

“And a steep yield curve indicates the bond market is predicting better days ahead long term, whereas the stock market is like a pingpong match.”