Is the Stock Market Divorced from Reality?

September 21, 2020

 

For almost everyone, normal routines have changed dramatically from earlier in the year. Every Friday until March of this year, my husband and I would go to our favorite sushi restaurant for happy hour, followed by walking around the mall and ending with a Godiva chocolate. Weekends were spent going to the gym, shopping and meeting with friends at restaurants. Now, however, all of these activities have been modified. Instead of seeing friends face-to-face we schedule zoom lunches. In lieu of attending a crowded gym, I bought a Peloton and other home gym equipment from Amazon. Walks around the neighborhood have become America’s favorite pastime, and my dog has even lost four pounds from his increased activity and attention!

 

With this shifting landscape in mind, it shouldn’t be surprising that some companies have prospered during these challenging times, while others—especially travel-related firms—have struggled. From its record high on February 19, 2020 the S&P 500 Index(1) fell 33.8% in less than 5 weeks as the news headlines grew more and more disturbing. But the recovery was swift as well. From its low on March 23, the S&P 500 Index jumped 17.6% in just 3 trading sessions, one of the fastest snapbacks ever among 18 severe bear markets since 1896. As of August 18, 2020, the S&P 500 Index had recovered all of its losses and notched a new record high.

Many individuals are confused by this turn of events. For those under the age of 75, the news headlines are likely the grimmest in memory: Millions have found themselves suddenly unemployed, and many companies such as Brooks Brothers, Neiman Marcus, and JC Penney have entered bankruptcy proceedings.

How can stock prices flirt with new highs while the news is so discouraging? One financial columnist recently observed that the stock market “looks increasingly divorced from economic reality.”
(2)

Is it? Let’s dig a little deeper.

The stock market is a mechanism for aggregating opinions from millions of global investors and reflecting them in prices they are willing to accept when buying or selling fractional ownership of a company. Share prices represent a claim on earnings and dividends off into perpetuity—current prices incorporate not only an assessment of recent events but also those in the distant future. In some sense, the stock market has always been “divorced from reality” since its job is not to report today’s temperature but what investors think it will be next year and the year after that and the year after that and so on.

Moreover, the universe of stocks does not march in lockstep. At any point in time, some companies are prospering while others are floundering. This year’s wrenching economic turmoil has inflicted great hardship on some companies while opening up new opportunities for others. Based on this admittedly abbreviated list, it appears the stock market is doing just what we would expect—reflecting new information in stock prices.

 

 

Past performance is not a guarantee of future results.

Source: YCharts. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. All figures are in US dollars unless otherwise noted.

 

No one could have predicted the tumult we have seen this year in financial markets. But investors would do well to focus on what hasn’t changed.

 

1. Markets are forward-looking, so focusing on today’s economic data is akin to looking

at the rearview mirror rather than the road ahead.

 

2. Broad diversification makes it more likely that investors capture market returns that are

there for the taking—including companies that do far better than expected.

 

3. Since news is unpredictable, a strategy designed to weather both expected and

unexpected events will likely prove less stressful and easier to stick with.

 

Bottom line: read the newspaper to be an informed citizen, not for advice on how to

navigate the financial markets.

 

 

Disclosure: Much of this has been adapted from an article written by Weston Wellington, a Vice President with Dimensional, one of the firm's market research experts.

 

1. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

2. Matt Phillips, “Repeat After Me: The Markets Are Not the Economy,” New York Times, May 10, 2020.

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