TCF intern Ellie Kaverman interviewed Jeff Madrick, director of the Bernard L. Schwartz Rediscovering Government Initiative, and Andrew Stettner, TCF senior fellow, about the stock market; their answers reveal how its status does not correlate with the health of the economy overall.
Ellie Kaverman: Jeff, I’d like to start by acknowledging that this conversation is occurring at a critical time. The United States just entered its seventh month of the COVID-19 crisis, and the pandemic has been disastrous for the economy. In August, the stock market had its best month since the early days of the pandemic in April, before a sudden drop in early September. The market’s recent growth paired with the fact that the wealth of U.S. billionaires has increased greatly through this pandemic seems to be in contrast with the experience of everyday Americans: twenty-two million people have filed unemployment claims, lines at food banks have grown longer, and it’s been reported that many children do not to have enough to eat. So what’s going on here? Is the stock market a historically reliable indicator of the strength of the economy?
Jeff Madrick: You’re right to raise these questions, Ellie. The market is often viewed as a rational indicator of the economy now, and of its future. President Trump often touts its successes as proof of the strength of the economy. But this idea that the market is an indicator of the future and closely linked to the real economy is mostly a myth. The market has often been extremely irrational, or else we wouldn’t have crashes. Before a market crash, is it rational to be valuing stocks so high? No. In the days, weeks, months, and even a year before any given crash, the market is actually quite irrational, and it’s not possible to anticipate that coming fall from its behavior. The late 1990s saw a huge run-up in Internet stocks, only to crash in 2000. Similarly, a big run-up in stocks ended in the 2009 market crash. Recessions followed. To say that stocks rationally and accurately reflect the future (as some analysts and even academics insist they do), isn’t just a naïve notion, but a dangerous one as well.
Ellie Kaverman: Why are stocks so high now, when so many people are suffering high unemployment rates and other harsh economic realities?
Jeff Madrick: There are several factors. One of the main reasons that stocks do not reflect the health of the economy most of us experience is the rise of stock buybacks. Companies often push stocks higher, partly and arguably, to raise the value of the stock options of their management by buying them on the open market. The 2018 tax cuts sponsored by Trump led to an inflow of cash for companies, cash that often went to buying back shares. Therefore no link to the economy, but cash sloshing around in company coffers.
But the current stock run-up, which has reached new highs, is first, and most importantly, due to the Federal Reserve injecting massive amounts of stimulus into the banking system. The Fed feared a serious recession when COVID-19 made it apparent that demand by unemployed workers would fall. This showed up in persistently low interest rates, and indeed the interest rates were and remain very low. When interest rates are low, stock prices are often stimulated higher for two reasons, one being because stocks are discounted by the time-value of money (which falls with rates) and the other being that people tend to put money in stocks when interest rates are so low bonds don’t have a serious payout. The Federal Reserve also announced that these unusually low interest rates will likely last for a while. The stock market has got to love that.
Another major factor driving stock prices up is the CARES Act, the government stimulus program which included supplemental unemployment benefits of $600 per week and loans to businesses. That kept the economy from collapsing even further. The stock market viewed these measures optimistically, with the hope that an economic recovery was on the horizon. The problem was that many provisions within the CARES Act were allowed to expire at the end of July, and we don’t know if we will have another stimulus. The Democrats in the House passed the HEROES Act back in May as the next stimulus, while Republicans in the Senate have offered at best a less stimulative package than CARES. Trump, in the meantime, claims the Democrats don’t care about the workers.
We have two factors: the Federal Reserve and the fiscal stimulus.
Ellie Kaverman: Are a handful of stocks carrying the market? If so, how does that fact affect how we read the relationship between the market and the economy?
Jeff Madrick: We know the stock market often doesn’t reflect the economy. But another new factor is that the stock market’s relative stability right now is coming mostly from only one sector: technology. The rises in stock prices is much stronger for technology companies than it is for most other companies. In fact, the disconnect is extremely wide at the moment. It’s not that the economy is doing well: rather, it’s that high-tech companies like Apple, Google, and Microsoft are doing very well. We have roughly five high-tech companies now accounting for 22 percent of the S&P 500. Stocks are going up partly because the stay-at-home economy favors the products and services that these companies offer.
We currently have a bifurcated market. The S&P 500 includes many high-tech stocks, whereas the Dow Jones 30 is actually well below its former high. Is the stock market actually reflecting this “super recovery,” or just the boom in high-tech stocks?
Ellie Kaverman: What are the concerns that we should have about the type of market that we have at the moment?
Jeff Madrick: I, and many economic analysts, are extremely nervous that this market is too speculative and too dependent on high-tech stocks. It even bears resemblance to the market in the late 1990s, when a stock like NetScape soared, only to collapse when Microsoft introduced a competitive product.
Today, we have some crazily soaring stocks that may not make sense on the future valuation, like Tesla; but people love the game. The recent drop in stock prices reflected the fall in a couple of key stocks. Many analysts think the market may collapse should just one or two of the fast risers hit a big bump in the road.
Andy Stettner: Stock market bubbles have been associated with our last several long-standing recessions. Has the run-up in the stock market today created additional risk in the way that similar run-ups have in the past?
Jeff Madrick: Yes, it is a speculative market, which is another major factor. Stock markets often reach speculative peaks. When they collapse, they often lead to recession as spending falls. We had a big recession in 2000 and again in 2008–2009. The Financial Times reported that the huge Japanese bank, SoftBank, bought billions of dollars of risky derivatives last month that sent the market higher. If SoftBank pushed speculation too far, which is likely, the bubble could easily burst.
Ellie Kaverman: You mentioned earlier the work-from-home economy. What is the connection between technology companies doing well because of the work-from-home economy and the economic reality for workers who are not able to work from home?
Jeff Madrick: You make a very good point. Many people, especially people of color, are not part of the high-tech economy but are rather part of the service economy. They are on the front lines, working in health services or hospitals. You can’t do these jobs online, and you are in jeopardy of contracting COVID-19 while at work. The stock market is not reflecting this disconnect in the economy, the one that’s between a small number of wage earners who are doing okay and a large number who are not doing well or are unemployed. The August national unemployment rate was 8.4 percent, and as many as twenty million people were unemployed at one point during the pandemic thus far. People who invest in the stock market assume most of these people will be reemployed in the near future, and that’s an incorrect assumption. It is one of the overly optimistic scenarios that market analysts often like.
Ellie Kaverman: How much can we attribute the market’s current run to investors anticipating a vaccine, or another stimulus from the federal government, in the near future?
Jeff Madrick: I think a lot of the speculation a few weeks ago was based on claims that a vaccine is on its way. Some of that has been tamped down now that we have more groups saying those claims were over-optimistic, and that kind of speculation is therefore playing less of a part in the stock market rise. However, even if a vaccine were imminent, its distribution would be going to be extremely difficult. And even if it were easy, is the economy going to bounce right back because people will feel confident in its efficacy and go right back to work, right back to shopping at Wal-Mart?
At the same time, companies are not going to rehire at the same rates as before the pandemic began, because they’ve changed their business models. One of the repercussions of this stay-at-home economy has been that some companies realize they can do with fewer in-house employees and still maintain an active online business strategy. Any optimism that we are going to come back in a “V” shape is just wishful thinking.
I think the anticipation of a congressional stimulus agreement has also contributed to the market. If we don’t get another stimulus, this economy is likely to collapse again. So, people investing in stocks have to believe that another stimulus is coming. The question is whether it will be an adequate stimulus. We don’t know if the stimulus will include the extra $600 per week of unemployment benefits, or if it will get bargained down, given the Republican $300 unemployment proposal; and we don’t know whether there will be new business loans. Small businesses particularly are suffering in ways we do not yet fully understand. There are economists who say that the economy will rev up on its own and does not need a stimulus, but that’s just not in the cards. This market is counting on a serious stimulus plan.
Andy Stettner: Normally we wait too long to act, but in this case the United States took quick action back in the early days of the pandemic, with Families First and CARES. Earlier in the pandemic, it seemed like businesses’ interests were influencing Trump most, but now it seems to have shifted. Do you think business interests want another stimulus?
Jeff Madrick: I think that the business community does think that it will get the stimulus, and that they want it. I think that they know they may not get $3 trillion, as proposed in the HEROES Act, but still have come to expect a moderate amount of stimulus. We are usually late on stimulus, but we don’t usually have a collapse in employment like we did this time. The COVID-19 recession is different than the ones in the past. Even conservatives recognized we had to do something sooner rather than later. We moved quickly because things collapsed so rapidly.
Ellie Kaverman: In a world in which the economy did come back in a V-shape, who would it impact?
Jeff Madrick: I’m not sure exactly which industries would benefit in the very unlikely case of a V-shaped recovery, but I would think the high-tech companies would continue to benefit, of course. Restaurants, travel, and tourism could come back. Retail as well. But that all depends on people’s willingness to return to spending, return to work, and, in turn, whether they trust a new vaccine.
People who have disposable income are buying cars and fixing up their kitchens during this time. And we know that housing, so far, has been okay economically. But again, it is high-income people who are the ones that stimulate the housing market. And there’s apparently a rush to get out of the cities which have been COVID-19 hotspots. So these things could definitely change the contours of demand. There are enormous unknowns that I just don’t think the overall market is capable of coping with. Even the rush out of the cities may be overstated.
However, I just want to reiterate that the economy is not going to come back in a V-shape. If it were, that would have begun months ago.
Ellie Kaverman: It’s interesting that you mention the housing market and how it has survived these crises pretty well, just as we have seen a renter moratorium finally put back into place by the Trump administration. Low-income people may not be buying houses, but they can’t afford to pay their rent. I think that shows there are two realities going on.
Jeff Madrick: I think there are two realities in America, and the “bad reality” is much larger than the “good reality.” The size of the population is bigger in the worse-off reality than the size of the population in the better-off reality. We have to seriously address how we maintain decent wages for these people on the front lines and in the services industry. And another four years of the Trump administration will not address that. And under Trump, forget about anti-poverty policies. Furthermore, even the stock market will ultimately be affected if wages are not supported, because the demand for goods and services will fall. We are now at a stage where what were once called furloughs are being changed to outright layoffs. We may be on the edge of a cliff, and we will all tumble off it without a new, serious stimulus and equally serious wage supporting policies.
Ellie Kaverman: In the stock market rallies that we have seen, how have they been unequal, and who is benefiting from them?
Jeff Madrick: People with pension funds are generally doing pretty well, but even though many have pension and retirement funds, they are not enough to live on. The stock market generally serves better-off people who have built up their savings. The stock market going up is just not the same as giving everyone an unemployment bonus. It is not the same as coming up with plans for job creation or a higher minimum wage. The Trump argument is that the market is showing that the economy is very strong, but that’s simply not true.
Ellie Kaverman: Do you think that stock market surges have lulled policymakers and leaders into a false sense of security?
Jeff Madrick: To some degree, yes. People look at their pensions or retirement accounts and feel they are not doing so badly. But the lack of jobs and the poor state of small businesses are far more depressing than anything the stock market can compensate for.
Andy Stettner: I think one thing to note is that economic signals are confusing and most people find it really difficult to make sense of it all. The housing market is stable, the stock market is stable, people are buying cars. Yet, unemployment is still very high and food insecurity is skyrocketing. How do you describe where the economy is at this confusing juncture?
Jeff Madrick: There are lots of sources of confusion, the most important of which is the course of the coronavirus. The future of the economy will depend entirely on the virus. But even if infections rates, hospitalization rates, and death rates fall significantly, it will not happen in the near future. Most people are not comfortable right now. Food insecurity for children right now is one in five. It’s clear that the bottom two-thirds of the economy are not doing well, and we’re not hearing much about them from the news. You can’t feel good when you’re facing unemployment and can’t afford to put food on the table, or if you have a small business that is dependent on loans that are now ending. Optimism that a vaccine will turn this all around is just unfortunately not realistic in the near term.
We must have a serious stimulus plan. Right now, we are looking at uncertainty over COVID-19 and a stimulus, while stocks are soaring because of the very likely false hope in high-tech companies. The stock market has often been dead wrong. This is a pandemic-based economic condition, and there’s a historical, massive new layer of uncertainty because of that.
header photo: Traders, some in medical masks, work on the floor of the New York Stock Exchange (NYSE) in New York City. Source: Spencer Platt/Getty Images