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Between March 23 and Aug. 1, the MSCI World Index surged 45%.[i] Meanwhile, global gross domestic product (GDP) was down sharply and unemployment was at historically high levels. How can the stock market climb while the U.S. economy is in a significant contraction and facing plenty of political and geopolitical uncertainty?
The economic pain and suffering tied to our current economic contraction are real. Many people are out of work, many businesses are in danger of bankruptcy and cities across the country face significant budget shortfalls. And yet, against this stark backdrop, stock prices march higher. Is this the sign of a world gone mad or of a new relationship between the market and economy? Should we worry or cheer? Stop investing or buy more stocks?
At Fisher Investments, we don’t believe stocks’ recent rise is a sign of madness nor that it marks a new disconnect between the economy and the stock market. Granted, COVID-19 has certainly offered plenty of novelty. In just a few weeks, it drove stocks from all-time highs into bear-market territory, due to the government-imposed economic lockdowns put in place to slow the spread of the virus. While the historical particulars and the social and cultural context are new and unique, what isn’t new, in our opinion, is the likely longer-term outcome.
The world currently faces plenty of problems, but we believe the longer-term economic prognosis is positive, despite shorter-term uncertainty. For long-term investors, as we explain below, the apparent disconnect between the economy and the stock market seems like a normal phenomenon, as bull markets often begin with jobless recoveries, only modest GDP growth and widespread investor pessimism. It may seem callous, but markets can climb despite widespread suffering caused by regional conflicts, civil wars and even global pandemics.
Stock Market Prices in Probable Outcomes
We believe the ongoing recovery means the stock market is pre-pricing a brighter future where the world has moved beyond the coronavirus or has learned to manage it so the economy can remain open and businesses continue to operate with some degree of certainty. This may seem strange, given the current state of the economy, but the stock market is forward-looking and, typically, stocks recover before a recession ends amid poor economic data and high uncertainty.
Some investors fear a second or third wave of coronavirus will scuttle the recovery, but we believe this widely discussed concern is likely already priced into the market. While an uptick in cases is undoubtedly bad news from a public health perspective, we believe it shouldn’t derail the new bull market currently underway — at least so long as it does not re-trigger sweeping shutdowns or institutional closures. Considering investors have long been aware of the risk of a COVID-19 resurgence, we believe it would need to lead to new widespread closures and restrictions, like we saw at the onset of the pandemic or worse, in order to substantially affect markets.
Still, you may reasonably ask, what sort of economic conditions do we need to sustain the stock market recovery? Is the recovery on shaky ground? We don’t think so and we explain why below.
Jobless Recoveries Are the Norm
Investors and commentators alike may fear that high unemployment makes the current recovery unsustainable. But bull markets often begin when unemployment is still high — sometimes very high — and stocks often post substantial gains before the labor market materially improves. At the beginning of the previous bull market, unemployment peaked at 10.0% in October 2009, while the stock market recovery began months earlier in June.[ii] In 1982, a new bull market began in August when unemployment was also above 10%. Unemployment stayed above 10% until June 1983, almost a full year into the then new bull market.[iii]
High, even rising, joblessness doesn’t prevent turnarounds because they don’t hinge on hiring. Turnarounds are usually driven by business investment. New hiring follows from this, but does not lead.
Investors can Hitch Their Cart to Modest GDP Growth
On the heels of a sharp decline in Q2 2020 U.S. GDP, investors may worry that the economy just won’t be able to grow sufficiently to fuel a recovery. However, GDP is a lagging indicator and it typically confirms a recovery after it has already begun. Stocks also don’t need runaway GDP growth to post strong returns. Investors can profit even when economic growth is slow. If you look at stock market returns from 1970 to 2018 relative to the following year’s GDP change, you can see this quite clearly. In years when GDP growth was only between 0% and 2.5%, stocks still posted average annual returns of 8.1% in the previous year, as shown in the chart below. (Remember, stocks are discounting future economic expectations.)
Any Economic Growth Is Good for Stocks
Source: FactSet; Yearly IMF IFS GDP Growth, Real Percent Change – United States, 1970–2019; GFD S&P 500 Total Return (gross), 1969–2018. Average return within GDP growth increments.
This leads us to conclude this stock market recovery is less fragile than many currently believe. It doesn’t need 5% GDP growth or the unemployment rate to drop overnight to 4% to continue. It might just need things to be modestly better than most expect.
New Bull Markets Are Born on Pessimism
Many investors are pessimistic right now, but this is also normal at the start of a bull market. Legendary investor John Templeton said “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Stocks typically begin climbing while many investors still have a dour outlook. Templeton’s sentiment curve shows how investor emotion tends to change throughout the market cycle and reminds us to be cautious of making investment decisions driven by emotion. Today’s pessimism also lowers the bar for news that creates positive surprise and pushes markets higher.
John Templeton’s Sentiment Curve
Note: Intended to illustrate a point. Does not reflect actual returns or market behavior.
Although many investors remain pessimistic and see multiple reasons this bull market could be derailed, we remain optimistic about the longer-term economic and market outlook. Current fears that high unemployment, lackluster GDP growth or a COVID-19 resurgence will drag down markets are not new and likely already reflected in stock prices. The world is far from perfect and uncertainty still swirls around how COVID-19 will play out, but if you wait for an all-clear signal from the world to invest (or reinvest, as the case may be), the bull market may take off without you — costing you dearly in missed returns.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: Factset, as of 08/25/2020. MSCI World Total Return Index, 03/23/2020–08/01/2020.
[ii] Source: Federal Reserve Bank of St. Louis, as of 06/18/2020. Unemployment rate, October 2009.
[iii] Source: Federal Reserve Bank of St. Louis, as of 06/18/2020. Unemployment rate, November 1982.