Stock Market vs. The Economy: Not the Same
Feel free to listen to the audio version on our Whiskey Hue podcast here.
As I myself try to navigate these interesting times, I feel a sense of responsibility to share with anyone who finds helpful, what I'm learning and what's truly happening to the markets during this chaos. If I can play some part in providing info that may help through this extremely chaotic situation, I should. Hopefully, the following provides some nuggets to guide you through this situation.
We'll discuss: 1. The 2 Super Powers in the world. 2. Socialism 3. US Economy 4. Stock Market vs. Economy 5. Examples why Stock Market is not the economy. 1. The 2 Super Powers in the world today: Right now 2 countries matter in the world: US and China. We are not purely Capitalist, they are not purely Communist. There are various mixes of Socialism and Capitalism that trickle into both economies. Let's discuss how... 2. Socialism What's happening today? Essentially: Fed Reserve and US Government has told Corporate America and companies comprising the stock market, there is unlimited money supply. You will get funding. This is the main reason the stock market has had pockets of rising the last few weeks. What is a Bear Market? As relates to stock market for this conversation, simply, when the market falls 20% from recent highs. The Stock Market recently has done this due to Covid-19. What is a Bull Market? A rise in Stock market of 20% from recent lows, the stock market has also recently done this. Can you look outside and honestly say we're back to normal? NOPE So why the Bull Market? One reason: right now the companies that represent the stock market are assured by the US Government and Federal Reserve "You're fine, grants/loans will be given and bonds will be purchased regardless if of high quality or junk bond status. This is socialism. Corporate socialism, and interestingly it's a Republican administration pushing this. I'm not a Bernie Sanders guy, but he has been pushing for this same scenario for individuals. Not at the Corporate level, but at the 330M people who make up American level. People, myself included, have said, "we can't do this, it's leaning too far into socialism for Americans to bite. But, the current administration is doing exactly that, albeit a far costlier version at the Corporate level. This is interesting because what do we learn here? Issuing trillions of dollars of debt apparently doesn't matter. It's no big deal!! How does it look on the other side of this? This is not meant to be a story of gloom and doom, nor am I trying to be an alarmist, I just want us all to be equipped with info to ride through in a healthy way, whatever cycle the economy is going through at the moment. The consumer is going to be broke or stretched thin at the very least. The stimulus packages, are great and will sustain people for a bit, which is much needed. But much more will be needed. We are going to be taxed heavily once we're back to normal. At Fed level, State level, Municipalities. At the most tangible example, traffic tickets will skyrocket once we're all back in the streets as that is a revenue stream for the city. 3. US Economy is Mixed The United States has a mixed economy, with features that flirt with both Capitalism and Socialism. What does that mean? A mixed economic system protects Private Property and allows certain economic freedoms in the use of Capital, but also allows for Governments to intervene in economic activities in order to achieve social stability for the public good. The Four Components of THE US ECONOMY 1. Personal Consumption 2. Business Investment 3. Government Spending 4. Net Exports
A "true" or "absolute" free market economy requires that all property be owned by private individuals and all goods and services be privately provided. Prices are allowed to fluctuate based on supply and demand, and all transactions are voluntary, not compelled or restricted by the government. Countries with the purest form of Capitalism 1. HONG KONG 2. Singapore 3. New Zealand
....all small with populations less than 8 million people. In the U.S. Government already controls entirely or partially many goods or services: 1. Education 4. Hospital care 2. Courts 5. Postal delivery 3. Roads It also provides subsidies to agricultural producers, oil companies, financial companies, utility firms approves licenses to practice/run funeral homes, financial advisor, real estate. There are also many regulatory agencies as well, FDA, FTC, Fair Labor Rights Act - so we've already had this mixed economy for quite some time. 4. STOCK MARKET vs the ECONOMY: They are influenced by one another, but they are not the same. The best analogy I've seen anywhere was given by Josh Brown, cofounder Ritholtz Wealth Management / CNBC personality. "There is a MAN, a LEASH, and a DOG." The man has the leash on the dog and they walk across the park. They start at the same place, and will end at the same place. The man will walk a fairly consistent & predictable pattern depending on the circumstances, mostly straight forward. The dog runs right, left, backwards, forward, zig zags. In our analogy, the man is the economy. the dog is the stock market. Jerome Powell, head of the Federal Reserve, people want him to react to the dog walking - the stock market (from our analogy), but his real job is to focus on the man walking - the economy. FED: in charge of monetary policy (money supply) Congress: in charge of Fiscal policy (spending)
Stock market is forward looking, economy is right now. Stock market is up 30% from its recent decline, why? Because it is being artificially propped up. The stock market can be manipulated to increase volatility, creating mini-markets, allowing fund managers to capitalize. And it's entirely legal. Managers of Hedge Funds, Retirement Funds, Pension Funds - all have a short term focus. They want and need to capture returns in a short time frame, so they can return it to people who have invested in their funds. Funds are set up in a number of ways, essentially, these are private financial organizations that take in money from investors - individuals to large organizations that park money with the fund in hopes of positive returns that beats the market. They have trillions of dollars to play with. Many fund managers are borrowing money because it's cheap right now, low interest rates to exercise scenarios similar to the following: Example: they buy Call Options, a contract to purchase a certain stock at a price higher than it is currently, which means they believe this certain stock is going to go up. They then buy the actual stock to raise the price of the stock, and then on the way up, buy Put Options which means they believe the stock will go down, dump the stock they bought earlier, so the price of the stock goes down. They're legally manipulating the trades and they'll time their trades to make money on either side of that trade. If you're a retail investor* who is trying to time the market, stay away, it's rigged and you'll probably lose money. People way higher than our pay grade, they will decide when the market goes up and goes down. The actual businesses behind these stocks are at a screeching halt which directly affects the economy (labor, consumption, etc) yet the stock market prices are going up, anyone who can justify that to me is the smartest person in the room.
*Retail investors comprise 30% stock trading volume vs. Institutional Investors comprising 70% Bond Market is $40 Trillion vs. $20 Trillion Stock Market. Bonds $700B trading volume/day vs Stocks $200B trading vol/day 5. Does the Stock Market indicate where the economy is going? SOMETIMES. Let's discuss 3 instances to see how they don't always influence each other or align. October 19, 1987 "Black Monday": 23% crash in one day. After a long running rally, the crash began in Hong Kong, spread throughout Asia, picked up steam in London and Europe and then hit New York City. The stock market crashed, but the economy didn't even notice. During Reagan years, all other indicators remained solid.
Dot Com Bubble of 2000: 1982 to 2000, US had an incredibly robust economy, and the stock market (outside of 1987), generally ticked upward, until year 2000 the stock market got a little heated, and fell off...driven by the Tech Sector and eventually bleeding into other sectors, and the economy eventually followed suit. Within a year we were in a fairly long recession. The stronger economy gained steam in 2003/04 until the Financial Crisis of 2008. December 2018: We had roughly 2.9% GDP, 3.8% unemployment, ~3M jobs had been added to the economy, then a sudden 5% drop in the stock market. The economy still did well through 2019, until the recent Covid-19 crisis ended the longest running Bull Market which began in 2009. Stock Markets react to fiscal policy (interest rates), geopolitics, natural disasters, as we can see in the examples above. The reason these Corona driven market swings will be a multiple of magnitude this time around, is because consumers aren't spending yet, and won't be able to for the foreseeable future.
The big difference between the market and the economy is that the stock market is forward looking, and it is unexpected events that primarily drive future stock prices. Thus, it doesn't even matter whether future news is good or bad. What matters is whether it's better or worse than already expected. So with all the bad news, unless things turn out to be worse than expected, stocks may provide good returns. That's exactly what has happened since March 2009.The stock market affects almost everyone because: its behavior affects bond market prices, which affect how much you pay for a mortgage or how difficult it is for you to get a loan and the interest you pay on that loan.
More to come on this soon, but strap in because it appears to be a bumpy ride ahead.