Personal Finance

The U.S. is in a recession but the stock market marches higher. Here's why there's a disconnect

Key Points
  • U.S. stocks, as measured by the S&P 500 index, cratered 34% due to the coronavirus pandemic.
  • They've since rallied more than 43% since the recent bottom on March 23, even amid economic carnage and widespread protests over the death of George Floyd. 
  • The stock market is buoyed by investor optimism about the economy in the future.  
An entrance to the New York Stock Exchange (NYSE) in New York.
Photographer: Michael Nagle/Bloomberg via Getty Images

Great Depression-era levels of unemployment. An economy in downward spiral. More than 100,000 dead from a killer virus. A nation in upheaval amid widespread civil protests. 

And a stock market that marches ever higher.

The recent U.S. market turmoil from the coronavirus pandemic feels like eons ago.

The S&P 500 cratered 34% from its high in mid-February to its trough on March 23, the quickest decline of its kind in history.

Yet stocks rebounded with vigor, despite bleak economic news and protests that have spread across the U.S. after the death of George Floyd, a black man, when a white police officer subdued him with a knee to the neck for several minutes. 

The U.S. officially entered a recession in February, the National Bureau of Economic Research said Monday. It's the country's first since the Great Recession a decade ago and its severity has drawn comparisons to the Great Depression, the country's worst economic downturn in the industrial era. 

As of Tuesday's market close, the S&P 500 had swelled 43% from its trough, within reach of fully erasing its recent losses.

In fact, a recent period of 50 trading days represented the biggest rally in the history of the U.S. stock index. 

It's a "huge disconnect" from reality on the ground, said Robert Jenkins, head of global research at Lipper.

"The disconnect from basic human suffering is shocking," Jenkins said. "It gets more and more insane by the day."

Today vs. tomorrow

However, the divergence makes sense for several reasons, according to market experts.

Namely, the stock market is not the economy.

Stock investors are looking beyond present conditions toward what they believe will happen in the future — which they're currently viewing with optimism, experts said.

Why there's a disconnect between the stock market and the civil unrest
Why there's a disconnect between the stock market and the civil unrest

"One is looking at today, the other is saying where am I going," Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, said of the difference between the economy and stock market.  

"The market is saying, 'We know where we are today, but where are we going tomorrow?'" Silverblatt said. "In this case, tomorrow is 2021."

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The Covid-19 public health crisis pushed states to shutter broad swaths of their economies starting in mid-March to quell the spread of the disease.

Nearly 43 million Americans have since filed for unemployment benefits, shattering prior records.

The country's 14.7% official unemployment rate in April was its highest level since the Great Depression, when it peaked above 25%. The rate rebounded to 13.3% in May after the economy added 2.5 million jobs during the month, but some economists are skeptical that trend will continue.

Meanwhile, gross domestic product, a measure of  U.S. total economic output, dropped 5% in the first quarter of 2020. The Federal Reserve Bank of Atlanta estimates GDP may crater nearly 51% in the second quarter.

Yet, the S&P 500 is down less than 1% since the beginning of the year.

Investor sentiment has been buoyed by phased state reopenings that have begun across the country and the expectation of a vaccine, which would help normalize the national economy as social distancing measures end, experts said.

That could point to a rebound in consumer spending, the linchpin of the U.S. economy, and retail sales, they said.

The widespread protests currently dominating the news cycle are unlikely to have a big effect on the stock market unless investors see a risk of long-term economic damage, experts said.

'Old news'

A 34% decline in the S&P 500 wasn't reflective of the pandemic's likely effect on the long-term U.S. economy, said Preston Caldwell, senior equity analyst at Morningstar.

"I would say the economic data is old news for the market's purposes," Caldwell said. "Right now, most market participants are looking beyond the [second quarter] to try to understand the second half of 2020 and beyond."

Meanwhile, a survey of financial advisors suggests they're taking a rosy view over the long term.

A quarter of advisors expect to increase their stock recommendations to clients over the next year, according to a joint survey published last Wednesday by the Financial Planning Association, Janus Henderson Investors and the Journal of Financial Planning.

Government stimulus measures also seem to have assuaged some investor fears, experts said.

The CARES Act, the $2.2 trillion coronavirus relief law enacted in late March, issued one-time stimulus payments to American households, expanded unemployment benefits and created a forgivable loan program for small businesses.

The Federal Reserve has also used aggressive measures to make sure businesses and municipalities can access ready cash.

Strength amid some of the market's largest companies — the so-called FAANG stocks, represented by Facebook, Amazon, Apple, Netflix and Alphabet (Google's parent company) — have also helped to offset weakness in other sectors like energy, Jenkins said.

However, it's not a foregone conclusion that the stock market surge will last, especially if the economic turnaround investors envision doesn't materialize, experts said.

A second wave of the coronavirus could require states to implement stricter social distancing measures and dampen consumer spending.

A failure to pass more government stimulus measures may also diminish investor sentiment, since consumers would have less cash flow to inject into the economy, experts said.

The $600 weekly enhancement to unemployment benefits is scheduled to end July 31. There may not be another round of $1,200 stimulus checks for individuals. And many small businesses that received Paycheck Protection Program loans have almost spent the entirety of their government funding.