Updated: Oct 28, 2020
Did you know that from 2000 to 2009, cheese consumption per person increased at the same rate as the number of deaths caused by becoming entangled in your bedsheets? Or that the total revenue from arcades rose at nearly the same percentage as new computer science doctorates during that same period?
Maybe a better example of correlation, or the mutual connection of two or more variables is the relationship between temperature and ice cream sales. Generally speaking, the warmer the temperature, the more likely people are to consume ice cream. On the other hand, cold weather tends to sway consumers away from cool treats thereby resulting in fewer ice cream sales. So, you could say that temperate and ice cream sales are highly correlated with each other; a fairly simple and straightforward concept.
Sometimes, however there are instances when two variables you'd think to be highly correlated like temperature and ice cream sales end up being precisely the opposite.
In the realm of medieval fiction, honor, bravery and nobility generally tend to correlate with a positive end to the hero's journey. But if you've seen the uber-popular TV series Game of Thrones, you'll know that being honorable, brave and noble correlates more with a devastatingly gruesome death than attaining the iron throne.
The same disparity in correlation can be seen in today's real-world stock market and economy. If you're like most investors, you've probably noticed the precipitous rise in the S&P 500 amidst business shutdowns, record unemployment and no vaccine in sight. You may be wondering, "If the economy is in such bad shape, why is the stock market going up"?
To tackle this question, it's important to understand and appreciate the amount of change the financial markets and economy have experienced in the past six months.
For starters, the federal government has injected trillions of dollars into the economy, the most in history, and pledged to do more. In addition to record-breaking Fed stimulus, technology stocks, including two companies valued at more than a trillion-dollars each, now represent almost 30% of the entire S&P 500.
On top of that, stock trading is now free and apps like Robinhood have made it quick and easy for newbies to start investing, causing what some have referred to as "dumb money" flowing into the market.
Compare all of that to an estimated -32.9% in U.S. GDP for the second quarter of 2020 and it should be evident now more than ever that the stock market isn't the economy.
The Fed Launches Its Biggest Bazooka Yet
Back in March of 2020, Congress passed a record $2.2 trillion dollar stimulus package known as the CARES Act. The package was intended to provide financial aid to individuals and businesses negatively impacted by COVID-19. Certain households received upwards of $3,400, small businesses were given access to forgivable loans and unemployment income saw a $600/week boost.
If that weren't enough, Fed Chairman Jerome Powell indicated to the public that, "We really are going to use our tools to do what we need to do here," later citing the strength and stability of the government and it's ability to do whatever it takes to get the economy back on track.
To summarize, we now have trillions of dollars in the hands of the general public on top of continued support from the Fed if and when needed. Sounds pretty reassuring, doesn't it?
The market sure thought so:
Since mid-March, the S&P 500 (As represented by SPY in the above) has risen more than 46% in price alone due in some part to the perception that the Fed will step in and bailout the economy at will.
So despite the never-ending onslaught of unanswered questions and concerns regarding timing of a vaccine, unemployment and other current economic factors, the market likes safety nets and is taking comfort in the Fed's willingness to intervene and prevent the economy from falling off a cliff. The stock market isn't the economy.
The Fab Five
When you hear financial pundits on TV refer to "the market," what they're referencing is the S&P 500, or an index that represents the 500 largest publicly-traded companies in the U.S. Of these 500 companies, about 135 are classified in the technology space and consist of some of largest businesses in the world. Some are so large, in fact that they've single-handedly lifted the market this year despite many others declining in value.
In a recent blog post, Ben Carlson, CFA cited a chart from Goldman Sachs illustrating the impact large tech companies have had on the market in 2020. As you can see, Facebook, Amazon, Apple, Microsoft and Google, 5 companies that remain relatively immune to shutdowns and quarantines resulting from COVID-19, have returned 35% through June of this year, with the remaining 495 falling 5%.
Not only is this statistic shocking, but it's a good reminder of what's driving the publicly-traded market, as defined by the S&P 500, not necessarily the broader economy which includes small, privately held businesses that aren't as immune to the coronavirus.
I wonder how the mom and pop restaurant index has performed year-to-date? Or how about the performance of private companies in general with fewer than 500 employees which make up the lion's share of all U.S. businesses?
The reality is that most restaurants are operating at a fraction of their capacity, small retailers are filing Chapter 11 and the extra $600/week in unemployment benefits has ended. And seeing as though consumer spending represents 70% of the U.S. economy, it's important we define which "markets" are reaching new highs as some are comprised of a few trillion-dollar tech behemoths while others include thousands of local dry-cleaners and pizza shops. The stock market isn't the economy.
Robinhood to the Rescue
Picture a world where a sea of millennials and Gen Zs are stuck at home with piles of stimulus cash watching their favorite social media influencer brag about how much money he made trading stocks for free. Sadly, this is the world we currently live in.
Since Robinhood launched back in 2013, other online brokerages have followed suit and reduced trading fees down to $0. In addition to free-trading, companies like Robinhood have used technology to make it incredibly quick and easy for investors to open a brokerage account and start trading.
But free trades and a sleek interface come with a cost. In 2020, the cost comes in the form of inflated stock prices resulting from uninformed investors flooding the market on the guidance and tutelage of social media (Dave Portnoy, founder of Barstool Sports with over 1.7 million Twitter followers pictured below).
On top of that, you have the unemployed receiving an extra $600/week, banks offering mortgage payment deferrals and $3,400 tax-free stimulus checks. Armed with all this excess cash, investors are spending their free time and money trying their hand at day-trading.
Granted, retail investors like the ones on Robinhood and TD Ameritrade aren't single-handedly moving the markets, but they do represent a large percentage of U.S. equity ownership and can exert a meaningful impact on stock prices like we've seen in 2020.
Don't get me wrong - I think it's good that people are investing in, and learning about the stock market. But these stimulus programs were intended to mitigate the risks and fallout from COVID-19 by helping households maintain their standard of living, not to buy 1,000 shares of Kodak because Davey Day Trader Global said so.
As of this publication, the $600 unemployment bonus has expired and Congress has yet to agree on a new stimulus package while daily trading volume continues to rise. The stock market isn't the economy.
What Should I Do?
If you're like most investors who are still trying to digest the dichotomy between the stock market and the economy, you may be wondering what changes if any you should be making to your portfolio.
While I can't comment on your personal financial situation, at the very least it pays to be informed. No matter what the financial headlines say today or next year, having a basic understanding of general market terminology and keeping up with current economic events will help you better assess, for example, the impact a handful of trillion-dollar companies have on the economy and more importantly, your retirement.
It also doesn't hurt to have a plan in place. Whether that's a targeted asset allocation of stocks and bonds or a full-on comprehensive financial plan, having a well thought-out and detailed guide will help you avoid making poor, emotional financial decisions like trying to make a fortune day-trading stocks, and make it easier to navigate through challenging economic times such as these.