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Don't let market upswings fool you into believing economic recovery is here

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The markets experienced a surge on Tuesday, with the S&P 500 index rallying above 3,000 points for the first time since March. 

While you may assume that the economy is on the road to recovery with these recent upswings, the stock market may not be the best gauge for the overall economic well-being of the U.S. Investors need to be looking at the whole economy, not just the market, and paying more attention to the potential cascading impacts of the coronavirus pandemic such as businesses bankruptcies and permanent unemployment, Liz Ann Sonders, Schwab's chief investment strategist, warns.

"We haven't done enough thinking about the ripple effects," Sonders says. Instead, it seems the market reflects the optimism around a potential Covid-19 vaccine and states reopening. While both are important aspects to follow, they do not tell the whole story of what the country is facing. 

There's less attention being put on the economy overall, Sonders says. That's an important distinction to make: The stock market is not a representation of the economy. The two are actually very different, according to Morningstar researcher John Rekenthaler. That's because while stocks tend to be forward-looking, their ups and downs don't always take into account all of the aspects that make up the economy.

The economy encompasses the total goods and services a country produces across all all industries, professions and income levels. But indices like the S&P 500 only track the business prospects of large companies. The effects of the coronavirus pandemic on these giant corporations have been relatively "benign," compared with the "awful showing of the overall economy," Rekenthaler says, especially when compared to small businesses and American households, both of which affect the overall economy. 

The recent stock market rallies don't reflect the potential ripple effects of the pandemic, such as permanent unemployment, Sonders says. Close to 80% of employees consider their job losses over the past few months temporary. "But, of course, the survey that generated that number was a survey of employees, not employers," Sonders says. "That's an important distinction."

"In the event of an actual bankruptcy, many of those perceived temporary job losses become permanent layoffs," she says. In fact, several major retailers, such as J. Crew, J.C. Penney and Neiman Marcus, have already filed for bankruptcy. 

Another ripple effect to watch: the impact of distance learning on college towns. Some universities have already announced they will not reopen for in-person classes in fall. That's likely to have a big impact not only on schools, but the surrounding communities. 

"Think about towns and cities where colleges dominate those landscapes and think about the ripple effects into services and restaurants," Sonders says. Many schools employ thousands and inject massive amounts of income into the local economy. But with students staying away, that may all take a hit. 

What investors should do amid the uncertainty 

For investors, particularly younger Americans who are investing for the long-term, it's important to put together and follow a financial plan, Sonders says. Think about what you're going to use the money you're investing for and the timeline for that goal.

Second, make sure you have a balanced, diversified investment mix. For most people, a balanced portfolio means that you're invested in different types of assets, such as stocks and bonds. Spreading out your money across different investments reduces your overall risk so that you won't lose everything if the market tanks.

Third, consider rebalancing. The markets have been far from static lately, so some investors may want to rebalance periodically to make sure that their investments are not off course. Let's say you set up your portfolio with 60% allocated toward stocks and 40% allocated toward bonds, which is fairly typical. Stocks have outperformed recently, so with their returns, your portfolio might now sit at 75% stocks and 25% bonds. By rebalancing, you can sell off a bit of your stock gains and put more money elsewhere, like into bonds.

Many investors do this on a pre-set calendar basis, usually quarterly or annually, Sonders says. But with the recent ups and downs, it may make sense to rebalance more often. "Try to maybe be a bit more nimble," she says. 

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