Barry Ritholtz writes about why stock prices are high while the economy stinks in this article.
Me: Stock prices plummeted between February 20 and March 23, during which news about the coronavirus grew rapidly, but have since recovered most of the drop.
The following are excerpts, especially for any reader who can't access the article.
“The economy many people experience, while bleak, is local, personal and, for the most part, either not publicly traded or plays only a small part in the stock market’s moves.”
“The most visible and economically vulnerable industries are also among the smallest, based on their market-capitalization weight in major indexes such as the S&P 500. Markets, it turns out, are not especially vulnerable to highly visible but relatively tiny industries. The 30 most economically damaged industry categories could be de-listed before tomorrow’s market open, and it would hardly shave more than a few percentage points off the S&P 500.”
“But the U.S. economy is not the stock market and vice versa. As we discussed before, ignoring overseas strength is a major oversight. The so-called FAANGs [Facebook, Apple, Amazon, Netflix, Google] (along with Microsoft) derive about half -- and in some cases even more -- of their revenue from abroad. Beyond that, the pandemic lockdown in the U.S. has benefitted the giant tech companies’ sales and profits. No wonder the Nasdaq Composite 100 Index, which is dominated by big tech companies, is up about 26% this year.
But a reasonable person might argue that GDP fell by about a third in the second quarter and the S&P 500 should be in synch with that. What’s more, of the 500 companies in the S&P 500, about 450 of them are doing terribly. Industries such as retail, travel, energy, entertainment, dining have seen sales evaporate. Bankruptcies are piling up -- legendary retailer Lord & Taylor is just the latest-- and more are surely coming. Yet, the S&P 500, after a huge plunge in March, is up 2% this year.
Market capitalization explains why.”
“So although high visibility industries may be of considerable significance to the economy, they are not very significant to the capitalization-weighted stock market indexes.”
“Consider how little these beaten-up sectors mentioned above affect the indexes. Department stores may have fallen 62.3%, but on a market-cap basis they are a mere 0.01% of the S&P 500. Airlines are larger, but not much: They weigh in at 0.18% of the index. The story is the same for travel services, hotel and motel REITs, and resorts and casinos.”
“Both before and especially since the pandemic, those six stocks [FAANG plus Microsoft] have been the biggest drivers of the market-cap weighted indexes like the Nasdaq 100 or the S&P 500. If your only frame of reference is a domestic economy, this is easy to miss.”