Why is the stock market doing so well?

This is the most frequent question that I’m asked — why is the stock market so damn high* while the economy is in a deep recession with record unemployment?

Any knucklehead can explain the past so, for what it’s worth, here’s my two cents on why the stock market has soared in the midst of a pandemic and deeply depressed economy. Three dynamics inform much of the stock market performance:

  1. Big Tech dominates the stock indexes.
  2. The federal government responded in an unprecedented manner.
  3. Interest rates are historically low.

1. Big Tech

The market capitalization of five super-sized tech companies — Apple, Amazon, Facebook, Google, and Microsoft — represents almost 20% of the overall US stock market. For various reasons, Big Tech is doing just fine and their stock prices have done quite well this past year. These five companies have an out-sized impact on the overall stock market performance.

We all observe the ongoing losses on Main Street but from a stock market perspective, they don’t matter much. Yes, many industries such as retail, airlines, commercial real estate, hospitality, health care, higher education, and other services have been devastated, but they have little effect on overall stock market averages.

And, the losses that these industries incurred have, so far, been cushioned by an aggressive federal response. That brings me to my second point.

2. The Federal Response

The federal government quickly passed legislation that sprayed trillions of dollars into the economy. The money has gone into all sorts of nooks and crannies — fair & unfair, big & small, corrupt & honest, wasted & efficient — and had the desired effect of sluicing cash immediately into the day-to-day economy to keep companies alive and people employed. The additional $600 per week unemployment benefit also greatly helped — keeping people fed, sheltered, and spending money.

This policy response was substantially larger than was done in the financial crisis of 2009, and nothing remotely like this was done in the depression of the 1930s. It has been immensely expensive but, so far, achieved the desired effect. This stimulus is winding down and the hope has been that the Main Street economy will now recover on its own. Maybe it will.

This was coupled with very low interest rates and that brings me to my third point.

3. Interest Rates

The Federal Reserve responded by immediately lowering short-term interest rates to near 0%. They’ve committed to maintain this posture, including stabilizing financial markets, for as long as necessary. Given their similarly aggressive response during the 2009 crisis, few people doubt their credibility.

Low interest rates have a powerful influence on the stock market. Simply put, when bond investments offer little return, investors move more money into the stock market where stock dividend yields are more attractive. All else being equal (it never really is), stocks are worth more when interest rates are lower. Also, lower mortgage rates can stabilize residential real estate values, giving consumers more confidence.

The Future?

As I said, explaining the past is easy but people really want to know the stock market’s future. There are lots of hot air prognosticators but, none of us is smart enough to help with that.

There’s also great uncertainty about:

  • the course of the pandemic and vaccine development
  • U.S. election politics
  • how quickly unemployment will improve, and
  • the dire financial condition of many state and local governments.

As Paul Krugman and others are fond of saying, the stock market is not the economy. This has never been more true than now.

So what should one do? My advice is always the same. Pick an asset allocation that fits your risk profile and circumstances, try to block out the noise, and stay the course. Focus on what you can control.

* The stock market was up ~21% in calendar year 2020.

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