The U.S. economy just had its worse performance ever as businesses shut down across the country as well as much travel decline.
Stephanie Schill, a married mother of two, was worried about her retirement savings when the coronavirus pandemic pummeled the global economy in the spring.
Schill, a marketing manager for a dental company in Johnsburg, Illinois, said the firm cut her salary by a quarter and eliminated her 401(k) match to conserve cash and reduce layoffs.
But the unprecedented event turned into a financial awakening for her, she says. Schill began maxing out her 401(k) after she saved hundreds of dollars on daycare costs with her two children at home.
“I want to retire as quickly as possible. Financial freedom will give me the flexibility to do that,” says Schill, 38, who had her salary restored after ten weeks. By that point, she found a new daycare for her children that was 20% cheaper. That put more money back into her pocket to invest, a plus since stocks were at bargain prices, she says.
“I’m going to keep plowing toward my retirement goals,” says Schill. “You can’t time the market. You have to remove the emotion regardless of the wild ride.”
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After stocks sold off in the spring, some Americans, like Schill, are happy with their retirement balances again following the market rebound.
On Tuesday, the S&P 500 rose 0.2% to 3,389.78, eclipsing its previous Feb. 19 high to finish at the highest closing level on record. That means this year’s bear market, or a drop of more than 20% from a peak, from the February high to the lows on March 23 was the shortest in history, according to S&P Dow Jones Indices.
While retirement accounts saw sharp swings in the second quarter due to the uncertainty surrounding the outbreak, investors boosted their IRA contributions, driving record-breaking flows to retail retirement accounts while contributions to 401(k) plans remained steady, according to Fidelity Investments.
So why is the stock market at records while the U.S. economy is in one of the sharpest economic downturns since the Great Depression? Here’s what the experts say:
Why a record in a recession?
Although stocks are back at highs, millions of out-of-work Americans are still suffering after a mind-boggling 56.2 million Americans sought unemployment aid in just 21 weeks.
But there have been signs of improvement in the labor market recently, which has helped rejuvenate investor optimism for the recovery.
“It’s not so much about good versus bad news. The market cares about whether things are getting better versus worse,” says Ryan Detrick, senior market strategist at LPL Financial. “The economy is still nowhere near its output prior to the pandemic. But things are getting better.”
The number of Americans seeking jobless benefits dropped to 963,000 for the week ending Aug. 8, falling below 1 million for the first time since the shutdown began in the spring, the Labor Department said Thursday. The figure still remains above a peak of 665,000 in March 2009 following the aftermath of the global financial crisis, and topped a previous record of 695,000 in October 1982 during another economic downturn.
Improved consumer spending, a rebound in the housing market and better-than-feared corporate profits have added to the optimism.
And in a sign that the U.S. economy is faring better than experts initially expected, the Citigroup Economic Surprise Index, which gauges the frequency that economic data beats Wall Street expectations, has hovered at all-time highs recently.
How is a stock market high possible?
The stock market has remained resilient in the face of the downturn. And higher stock prices during recessions aren’t unusual, if history is any indication. Stocks have risen during seven of the past 12 recessions going back to World War II, with a median advance of 5.7%, according to LPL Financial.
Differences also exist between the stock market and the economy. The S&P 500, for instance, is driven more by manufacturing, while U.S. gross domestic product, the broadest measure of goods and services produced by the economy, is propelled by the services sector, according to LPL Financial. The latter took a bigger hit due to social-distancing measures from the lockdowns, as consumer spending accounts for more than two-thirds of U.S. economic activity.
The benchmark index is global, with roughly 40% of sales from S&P 500 companies derived internationally, while U.S. exports account for just 13% of GDP. The S&P 500 is also driven by capital investment, which has been supported by technology spending during the pandemic.
Another reason is because investors view the markets as forward-looking, anticipating how the U.S. economy and corporate earnings will perform in the next six to twelve months. Optimism has grown with hopes for a vaccine and further stimulus.
“Economic data has improved as parts of the country have gradually reopened. And we’re getting closer to a vaccination and therapeutics, which is important because it’s going to affect the direction of the economy over the next six to nine months,” says Megan Horneman, director of portfolio strategy at Verdence Capital Advisors.
What’s next for the stock market?
Stocks could be poised for more gains in the coming months, analysts say. One key reason: Stock market investors are betting that the pandemic will end eventually with a vaccine. And large rallies are usually followed by continued gains, analysts say.
The S&P 500 has averaged a 46% return in the 12 months following the start of a new bull market, according to research firm CFRA, which analyzed data going back to 1932.
But any setback in the timeline for developing a vaccine could challenge the stock market’s rebound, experts caution. With the U.S. presidential election less than three months away, some investors remain cautious due to economic policy uncertainty. Renewed trade tensions between the U.S. and China have added to those concerns after both countries reached a deal in January that brought a truce in a tariff war.
Some market professionals worry that a stalling U.S. recovery could slow the rally. Investors hope for another coronavirus rescue package from Congress to help sustain the economic rebound, but talks among Republicans and Democrats hit a stalemate this month.
Even so, some investors are looking past those risks.
“Many businesses have failed and there’s been a lot of permanent damage,” says Thomas Martin, senior portfolio manager at GLOBALT Investments. “But once there’s a vaccine, we would limit that damage and the economy could be resilient.”
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