Each day, it seems, the stock market moves closer to its February peak. After a late-winter plunge that erased roughly $7 trillion in household wealth, the S&P 500 index has recovered nearly all of those losses. Are investors in the market oblivious to the ongoing damage from COVID-19? What about the upheaval over the death of George Floyd? Have they turned a blind eye to the growing conflict with China? Or is the market trying to tell us that we are going to get through these formidable challenges largely intact?
Economists have often questioned the wisdom of the stock market. Nobel prize winner Paul Samuelson famously remarked that the stock market had called nine of the previous five recessions. Nonetheless, it is worth keeping in mind that investors have a strong incentive to utilize all the information and wisdom available to get things right, especially the outlook for profits. That outlook is highly contingent on prospects for the economy. Thus, investors pour over with a fine-toothed comb all the news bearing on the economy—especially the labor market. But stock prices also depend on other things, notably, yields on competing investments, such as bonds, and investor perceptions of risk, which become inflamed by uncertainty about the direction we are heading.
As the severity of the pandemic became more evident over March and the lockdown paralyzed the nation, it became increasingly clear that a sharp downturn in the economy and profits could not be avoided. At the same time, uncertainty about where we were headed soared. The stock market plummeted. But, by the end of March, unprecedented fiscal measures and an ever-expanding roll out of Federal Reserve programs were convincing investors that the damage was being contained. In response, the risk premium abated, and the market began an upward climb. Also giving impetus was the realization that yields on competing investments will remain extraordinarily low for some time. More recently, market participants have read the news on the labor market, the opening of more sectors of the economy, and prospects for a COVID-19 vaccine as pointing to an imminent, sustainable economic recovery. These developments have encouraged participants to revise upward their expectations of profits.
The labor report for May seems to have confirmed the optimism displayed by the stock market. The 2-1/2 million increase in employment is remarkable when considering that more than 12 million workers filed new claims for unemployment insurance between the survey weeks in April and May. This means that a vast number of unemployed workers returned to their jobs last month. This can be seen in the chart showing that the number of persons continuing to collect unemployment insurance benefits has been declining over recent weeks, even as new claims have been on the order of 2 million per week.
Burrowing into the May jobs report, it is clear that we have begun to dig out of the recession. Employment in the hospitality and retail sectors—which had been among the hardest hit—registered large gains. Moreover, construction employment retraced a good portion of its decline over the previous two months. This suggests that the housing sector—which had been on an upswing before the pandemic—seems to be on firm ground. Manufacturing employment also registered solid gains, including at virus-slammed food processing plants. Ironically, one of the more encouraging findings was a decline in average hourly earnings. This confirmed that most of the job gains were among low-wage workers who had been hit the hardest by the lockdown.
The May jobs report notwithstanding, the second quarter of this year will record a double-digit contraction, likely the sharpest on record. And the unemployment rate in May, at 13.3 percent, still stood above those in previous postwar recessions. But recent data, including the stock market, are increasingly pointing to a V-shaped business cycle. See my earlier piece, “Is There a ‘V’ in the Corona Virus Shock?” Also, I discuss the importance of financial markets as a disciplining force in a market-based economy in Chapter 2 of my book, Capitalism Versus Socialism: What Does the Bible Have to Say?