Watch: Are Stocks Disconnected from the Economy?

At a Glance

  • Fed liquidity and a reliance on tech has helped stocks move toward record levels despite high unemployment
  • Household liquidity remains low, which could bring additional economic risk

The Nasdaq reached new record highs in early June. Meanwhile, the unemployment rate in the United States sits at 13% despite an unexpectedly positive May jobs report. These two data points wouldn’t seem to go together. However, in 2020 it defines the disconnect we often hear about between the stock market and the “real economy.”

In February, before COVID-19 reached pandemic levels in the U.S., unemployment was at a half-century low of 3.5%.  But how has the market recovered as quickly as it has while almost 42 million Americans have lost their jobs since the economy came to a grinding halt?

Fed Liquidity Has Helped…

The Federal Reserve came to the rescue to support the economy.  They slashed interest rates to near zero, purchased an unlimited amount of Treasuries, and launched crisis-era lending facilities to ensure credit flows to households and businesses. The Fed has pumped nearly $2.9 trillion into the economy and its balance sheet has expanded to $7 trillion, a record.

…But People Need Cash

Data from Bankrate shows that, on average, Americans are not keeping much in liquid assets. The numbers range from $1,350 for single people 34 and younger to $17,587 for couples 55-64 with children. This does not include money held in tax-advantaged vehicles like a 401k.

Those are scary numbers.

This tells me that people may be one sewer line collapse, one roof replacement or one flooded basement away from liquidity ruin. But the data is not all horrible. Even if you do not own or trade individual stocks, there is a decent chance you have a 401(k) account or an Individual Retirement Account or belong to a pension fund that is invested in stocks.

A once-every-three-years study by the Federal Reserve Board found that in 2016, 51.9% of families owned stocks, either directly or as part of a fund.  And in 2017, Gallup found that 54% of respondents owned stocks either directly or as part of a fund.

The Market and Economy Might Be Closer Than We Think

Where does this leave us?  First, as awful as the unemployment figures are, many have thought they should be worse. Second, the stock market is not really a good barometer of the economy and, if anything, is forward-looking. Third, interest rates are near rock-bottom. Fourth, in addition to the government stimulus mentioned above, Congress passed the $2.3 trillion CARES Act which provided stimulus payments to individuals and grants to businesses that retain their workers.

Finally, the biggest tech companies now make up a larger and larger part of both the S&P 500 Index and NASDAQ.  Microsoft, Apple, Amazon, Alphabet and Facebook combined to make up over 20% of the S&P500 and NASDAQ as of the end of April.

That means technology is carrying a disproportionate share of the market, and economic upheaval like we’ve seen in 2020 could benefit certain sectors of the market more than others.

There is some disconnect between the stock market and the economy, but in many ways the two elements are rarely fully aligned.

Watch our roundtable discussion on the U.S. Economy vs. U.S. Stocks above.

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Scott Bauer graduated with honors from the University of Illinois Business School, Urbana Champaign, in 1988 with a B.S. in Finance. Bauer began floor trading in 1991 and formed BOTTA Capital Management in 1995. Scott traded equity options, S&P options at CME and was employed by Goldman, Sachs & Co. as Vice-President, Equities Division. He is currently CEO of Prosper Trading Academy and appears regularly on CNBC, Bloomberg Financial and Fox Business as a guest commentator.

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