Why the S&P 500 Just Hit a Record Even Though the Economy Is in Shambles

An illustration shows the Dow Jones's performance and a man sitting with a laptop
Getty Images and Chris Zuppa/The Penny Hoarder

Congress is deadlocked over the next stimulus bill. Officially, 10.2% of people are unemployed, though economists say the actual number is much higher. Expanded unemployment benefits expired last month, leaving millions of people unable to pay their bills.

So with so much economic turmoil, why is the stock market on fire? The S&P 500 set a record on Tuesday, erasing coronavirus losses and inching above its previous February 2020 high.

Did Wall Street miss the memo about how bad things are right now?

Why the Stock Market Is So Good in Bad Times

It really isn’t that surprising that Wall Street seems so out of sync with Main Street. Here are a few explanations for why stocks can soar, even when the overall economy is in the dumps.

Small businesses are struggling, but they aren’t represented on stock indexes.

When you hear on the news that the stock market had a good or bad day, that usually means the major stock indexes were up or down. The big three are the Dow Jones Industrial Average, the S&P 500 and NASDAQ. They track the stock prices of some of the biggest corporations in America.

But guess who’s not represented in a stock index? Your local baker. Your favorite watering hole. The guy who cuts your hair. Your child’s preschool.

And these are the businesses that are struggling most: About 1.85 million small businesses closed or temporarily suspended operations during the second quarter of 2020, The Wall Street Journal reports.

Small businesses have laid off more people than larger companies. They’ve reduced the number of employees by 40% since January.

Because small businesses usually don’t have large cash reserves, many couldn’t survive even a month or two with no income or severely restricted operations.

And those big publicly traded companies often gain when their smaller competitors close. After all, if you can’t buy a cake from your local baker, you might end up buying one from a big grocery chain instead.

The stock market only tells us what investors think will happen.

The stock market isn’t a snapshot of where we’re at. It just tells us where investors think we’re heading.

Think about it: You’d buy stock in a company if you think it can earn money. You wouldn’t care if recent profits had been dismal if you think better times are ahead.

You’d sell stock in a company if you think it will lose money. You also wouldn’t care how great profits have been in the past if you don’t think the profits could continue.

Apply those principles to the entire stock market. Soaring stock prices show that investors think companies can make money moving forward.

“The stock market is a leading economic indicator that attempts to tell us where we are going, not where we are or where we have been,” said Matt Elliott, a certified financial planner and founder of Pulse Financial Planning. “While it is not always right, it is a better indication of where the economy is headed than looking at unemployment, GDP or other statistics that only tell us past information.”

Case in point: Stocks plummeted back in February as investors panicked over potential virus-induced catastrophe. But that was before coronavirus cases exploded in the U.S. and people began losing their jobs en masse.

Investors think we’ll have a quick V-shaped recovery…

States have reopened. There’s optimism about a coronavirus vaccine.

Many investors think those factors will give us a V-shaped recovery, meaning the economy will shoot right back up after crashing.

And it isn’t just seasoned traders hoping to enjoy the ride up. A lot of stock market newbies have jumped in as well. CNBC reports that Ameritrade, E-Trade, Charles Schwab and Robinhood had a 170% increase in new brokerage accounts during the first quarter of 2020 compared with the same period in 2019.

… but investors aren’t always right.

Even epidemiologists don’t know what the coronavirus will do over the next few months. So it’s not like investors know how this all shakes out.

“I fear that the recovery is more likely to be W-shaped — that is, a recovery, subsequent drop, and another slower recovery,” said Robert R. Johnson, a chartered financial analyst and professor of finance at Creighton University in Omaha. “I base this on my belief that many Americans seem to be ending social distancing prematurely. That is, prior to the creation of an effective vaccine and that a secondary outbreak of coronavirus could force another round of social distancing, stalling the recovery.”

The question isn’t just about what coronavirus will do. We also don’t know what Congress will do.

Expanded unemployment benefits provided by the CARES Act protected many of the newly jobless from financial collapse; in some cases they were receiving more than they did at their jobs.

But those benefits expired in July, and there still aren’t enough jobs for all the people who still aren’t working.

Many economists say a W-shaped recovery is likely if Congress doesn’t provide more relief.

Amazon, Apple and other tech giants mask reality.

Amazon, Apple, Microsoft, Facebook and Google parent company Alphabet account for more than 20% of the S&P 500. That means when stock prices for these companies soar, it can mask the struggles of smaller companies whose stock prices haven’t recovered much.

These companies have also gained from people staying at home. After all, we’re doing a lot of shopping online. We’re spending more time on social media. We’re connecting with friends, family and co-workers using devices instead of seeing them face to face.

But the picture is a lot different in other sectors, like travel and hospitality. Stock prices for smaller companies have also been slower to rebound.

The Federal Reserve made it easier for corporations to take on debt.

When corporations and governments need to borrow money, they issue bonds to investors. But as coronavirus crashed the economy in March, a lot of struggling corporations didn’t have many investors eager to buy their bonds, so they couldn’t access the credit they needed to survive.

But in March, the Federal Reserve stepped in and said that it would buy corporate bonds, which it’s never done in history, as NPR’s Planet Money explains.

Suddenly, even distressed companies like Boeing and Carnival could issue bonds and access credit again — and stocks have rallied based on the Fed’s willingness to step in.

The weird thing is, the Fed actually hasn’t bought many bonds just yet. Struggling corporations have been able to find willing investors just based on the Fed’s promise that it will step in and buy bonds if necessary.

Of course, just because a company can issue bonds again doesn’t mean its underlying business is any healthier. A company can’t survive long term if they can’t bring customers back.

OK, So What’s a Typical Investor Supposed to Do?

You and I don’t know more than scientists about how the coronavirus will behave, so let’s not invest as if we do.

The smartest thing you can do is to budget a certain amount to automatically invest each month, regardless of what the market is doing. No one knows whether we’re in a V-shaped recovery or whether that “V” is about to turn into a “W.”

The rule of thumb is, don’t invest money in stocks that you’ll need in the next five years — and that’s especially important in a volatile market. Then, ignore the day-to-day fluctuations of the money you do decide to invest in stocks.

“Don’t take any sharp turns or make erratic moves in the midst of turmoil,” Elliott said. “Don’t worry about what position your portfolio is in in the short term, as the short term is and always has been unpredictable. Position your investments for long-term success, and stick to that plan through good times and bad.”

Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].