As of this writing, financial markets are at all-time highs. At the same time, unemployment is at its highest since the Great Depression, small businesses are struggling, many of them closed and never again to re-open and some thirteen percent of the nation is on public assistance for food. How can financial markets be breaking records while many people depend on the equivalent of depression-like breadlines for sustenance?
The co-existence of booming financial markets with such national economic anxiety and depression- like conditions could not have been predicted during “normal times.” But as all agree — among the very few things on which all can agree — these are not normal times. The best we can do is to attempt to explain the irrational.
For starters, the co-existence of record-breaking financial markets and the need for widespread public food assistance demonstrates beyond all doubt that the stock market is not the real economy.
President Trump reminds us that high-flying stock markets are good for retirement funds. That statement is true. But it is pure eyewash, cover for the broader truth that some eighty percent of stock wealth is owned by about ten percent of our citizens, approximately half the population own no stocks whatsoever, and some who possess retirement funds have prematurely tapped into them in order to meet their living expenses.
In short, buoyant financial markets disproportionally benefitting the “haves” of our economy starkly illustrates, and exacerbates, the growing economic disparity between the “haves” and the “have nots.” This disparity of income and wealth started growing rapidly during the late 1970s and early 1980s, increased steadily over the following decades, and was further magnified with Trump/Republican economic policies, only to be still further increased by this pandemic.
In theory, investment decisions are based on the present value of expected future returns, this based on expectations and interest — technically, discount — rates. For stock markets, expected returns are comprised of dividends and changes — hoped for increases — of price of the stocks. As a practical matter, investors in stocks don’t go through these technical calculations when making investment decisions. Nevertheless, these factors, particularly interest rates, do profoundly affect stock prices — more on this below.
But first, investors putting money into retirement funds are spared the burden of the above calculations. They generally have the option of selecting from a variety of funds consistent with their age and risk tolerance, and they automatically place a fixed monetary sum into the market every payday. This is a wise strategy as it amounts to dollar-cost averaging, and eliminates “timing the markets,” an exercise at which not even professional money market managers consistently excel.
While steady flows into retirement funds ensure a steady stream of buys, and thus some upward lift to financial markets, it does not explain record highs. This brings us back to our theoretical calculations involving interest rates once again, and its practical effect on financial markets.
During tough economic times, a combination of low demand from borrowers, and Fed policy of keeping short term interest rates low, result in just that — low interest rates. To be technical again, applying a low discount rate places a higher value on expected future returns than would a higher discount rate. The practical, and easier to understand, result is that a low interest rate environment makes dividends, and possible appreciation of stock values, more attractive relative to alternative investments. Therefore, prices of stocks are bid up.
At risk of over-simplification, in a low interest rate environment such as today, for those looking to where to put their money, stocks are the only game in town.
Big time money managers and professional investors keep a close eye on Fed policy and interest rates. The Fed target for inflation has long been at two percent. Whenever the economy tightens, Wall Street gets as nervous as a cat in a roomful of rocking chairs, worried that the Fed will raise interest rates, seen as a damper on the stock market. But Fed Chair Powell recently indicated that the Fed will not likely immediately raise interest when inflation reaches two percent. Instead, it would average in a higher-than two percent inflation rate with preceding lower rates. The net result would be a delay in raising interest rates and “good for the stock market.”
To put a finer point on a technical explanation for high stock indices, consider stocks that have done well because of, or in spite of, the pandemic. Stocks such as Apple, Amazon, Microsoft, Zoom, Alphabet, and a few others that have done well are also high priced stocks that disproportionately affect the price-weighted DOW, large capitalization stocks that disproportionally affect the cap-weighted S&P, and tech stocks that dominate the NASDAQ. While these stocks have done well, many of the more traditional stocks that have lagged also have a lesser effect on the indices.
The above are among the reasons for high-flying financial markets during a soft economy, reasons that readers can accept or reject in part, or totally. To re-emphasize, this is explanation, not prediction. Nor is it advice — that’s between you and your financial advisor.
As for the future of the stock market, predictions of the gurus vary from an impending crash to soaring prices. We do know that when markets are “ready to fall,” as if they have a mind of their own, they fall much faster than they rise. And we know that over time, markets have risen — those who stayed out of the markets have missed out on impressive gains.
But in this age of uncertainty, we can neither time the markets, nor anticipate when nasty surprises or disasters will occur — just as we can’t predict when this pandemic will be under sufficient control that we can get back to what passes for “normal.”
And finally, we know that apart from getting this pandemic under control, this economy has numerous problems that need serious attention. Ignore the divisive political rhetoric, we’re all capitalists — the challenge is to make capitalism work for all.
— John Waelti of Monroe, a retired professor of economics, can be reached at jjwaelti1@tds.net. His column appears Saturdays in the Monroe Times.
