The great divergence

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November 19, 2020

How were markets able to keep climbing when economic data was signaling cause for concern? While 2020 has been filled with unpredictable events, the stark divergence between market and economic data through the spring and summer was still surprising. According to Liz Young, director of market strategy at BNY Mellon Investment Management, some of it came down to timing.

Economic data is essentially backward looking. Each month, the Bureau of Labor Statistics (BLS) announces the US unemployment figure from the previous month.1 The BLS also provides consumer price index (CPI) readings from the previous month. Similarly, the Bureau of Economic Analysis (BEA) announces GDP growth from the prior quarter. But price action seen in the market, which reflects market sentiment, or how traders and long-term investors think fundamentals could look in the future, represents forecasting, according to Young.

“When you get economic data, it is typically backward looking. Whether its jobless claims, GDP or inflation. It’s about what happened last week, last month or last quarter,” she says. “But market data looks at what’s going to happen in the next six, nine or twelve months. What’s going to happen with earnings? Are things going to be better or worse than they are today? And to what degree are they going to be better or worse?”

Of course, not all economic data can be characterized as lagging indicators. For example, the Purchasing Managers Index (PMI), derived from monthly surveys of manufacturing and service sector companies can be seen as a forwardlooking indicator of economic conditions. But for the most part, economic data reflects what has already occurred— not what is to come, Young says.

Covid-19 disconnect

In June, only three months after Covid-19 prompted lockdowns across the US, the S&P 500 had already rallied 43% from its year-to-date bottom, on March 23 [Figure 1]. The rally represented market optimism surrounding hopes of future economic resurgence.2

However, this was contradictory to what was occurring in the real economy. From March to June, the US unemployment rate shot up from 4.4.% to 11.1% [Figure 2].3 While unemployment did teeter off following its April high of 14.7%, that wouldn’t explain why the S&P still rallied roughly 800 points, or 36%, between March 23 and May 29,4 since investors would have to wait until June for the BLS to report the positive change in unemployment.

This shows the market was not trading based on unemployment data—at least, at first. It’s worth adding, the market also continued to rally through July, after the BEA reported the US economy had contracted at a 32.9% annual rate from April through June, its worst on record.5

While unemployment and stock market performance should move inversely, there may have been other factors at play. In fact, when the nation’s economic powerhouse,6 New York City, first underwent lockdown, it was only supposed to last one month. That was before New York State Governor Andrew Cuomo extended it for another month, to May 15.7 Then, the city’s residents discovered they would have to wait yet again as the city didn’t begin to emerge from lockdown until the start of June.8

One reason the market may have rallied without a strong rebound in employment is because investors did not anticipate lockdowns would last so long. Likewise, when restrictions were eventually lifted, that may have provided confidence even when the economy was contracting. While things have since gotten better from an economic perspective, there is still need for help, according to Young.

The great convergence

“Right now, small businesses suffering in cities across the US are not represented in the stock market. Many of them are privately held. So, the market is going to act independently from them,” Young says.

“However, at some point, businesses that have shutdown permanently do start to impact the real economy because those employees stay unemployed and it becomes an ongoing labor issue in regard to unemployment and business confidence.”

If more businesses permanently shutdown, recovery in the labor market, as well as business and consumer confidence could hit a snag or take a turn for the worse. In that scenario, we would likely see a quick reversal in market sentiment as investors try to digest what the change in confidence means for future economic prospects. “That’s why the timing of the next fiscal package matters, Young says. “If it takes the government too long to get a fiscal package out, we may run the risk of seeing another big wave of bankruptcies and another big wave of layoffs, and that would likely surprise the market to the downside,” she says.

“However, we remain optimistic that 2021 holds a lot to look forward to and although the next few months could be fraught with virus headwinds and political rhetoric, the end may be finally in sight,” she concludes.

1 The Bureau of Labor Statistics: Labor Force Statistics from the Current Population Survey. Accessed November 2020.

2 CNBC: The US is in a recession but the stock market marches higher. Here’s why there’s a disconnect. June 3, 2020.

3 The Bureau of Labor Statistics: Civilian unemployment rate. Accessed November 2020.

4 MarketWatch: S&P 500 Index. Accessed November 2020.

5 CNN Business: US economy post its worst drop on record. July 31, 2020.

6 World Economic Forum: This 3D map shows the US cities with the highest economic output. September 24, 2020.

7 US News: Cuomo extends lockdown, expands mask requirement. April 16, 2020.

8 NBC News: New York City emerges from coronavirus lockdown and begins phase one of reopening. June 8, 2020.



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