The Weekly Sift

Unemployment has hit levels not seen since the Great Depression. More than 10,000 Americans are dying every week with no end in sight. And the Dow is up 33% since March 23.

Friday morning, the April jobs report came out, and it was horrific: The economy lost 20.5 million jobs in April, and the unemployment rate soared to 14.5% — territory not seen since the Great Depression. And there’s no reason to think it won’t go higher. (If you can’t read the graph below, click on it to go to the CNN article where I found it.)

So naturally, the Dow Jones average proceeded to go up 455 points. That jump was weirdly typical of how the market has been behaving lately. In March, when the economy was being shut down, the Dow plunged in a way that seemed appropriate to the unfolding disaster: from its all-time high of 29,568 on February 12 down to 18,213 on March 23. But since then the market has had a nice rally, making up more than half its losses and getting back to 24,331.

Another way to look at it is in time rather than dollars: Friday the Dow closed 1,000 points higher than it was at the start of 2019. Can you remember back 16 months or so? Unemployment was 3.7% then, not 14.5%. Did that strike you as a less promising time than right now? Did you have more confidence in the economy? Less uncertainty and fear?

Among people who don’t study investing, facts like these are usually taken as signs of collective insanity, or maybe evidence of a vast market-manipulating conspiracy of the super-wealthy. And while collective insanity has been known to strike the market from time to time, and I’ve never regarded the super-wealthy as entirely trustworthy, there are some reasons why the market is where it is. Several recent articles (Emily Stewart’s in Vox is my current favorite) review those reasons, which I will try to summarize in my own way.

Forward-looking? I need to start by debunking a bad explanation. One old saw you will hear repeated at moments like this is: “The market is forward-looking.” In other words, things may look bad right now, but the market is looking ahead to conditions six months or a year down the road, when the situation will be much better.

Really? If that’s what investors are thinking as they bid prices up to this level, then I’m thrust back into the collective-insanity explanation. It’s definitely possible that some of our current uncertainty will resolve in a positive way over the coming months: Maybe phase-two vaccine trials will look promising. Maybe remdesivir or some other anti-viral drug will turn out to be an effective treatment, or just limit the lethality of the disease. Maybe curve-flattening will keep working even as we start to open more businesses, so that we hit some sweet spot of a better economy without a worse public-health situation.

None of that is unreasonable to hope for. But it’s also not assured. So far, the death numbers have stayed stubbornly high, and a lot of states’ opening-up plans have lacked the care and thoughtfulness many of us expected. (The Trump administration decided not to publish the CDC’s guidelines for opening various kinds of businesses safely. My guess is that Trump’s people thought they would be too discouraging. If that’s what it takes to open safely, lots of businesses might just stay closed. Much better, the Trumpists think, just to go ahead and encourage them to open unsafely.) The virus appears to be making the transition from urban areas to rural areas. If there is a weather effect, and infection numbers go down in the summer, they might snap back in the fall. There’s still no good plan for re-opening the schools, and how are you going to get parents back to work until their kids have somewhere to go?

In short, pessimism has its case too. And in addition to the epidemiological pessimism, you might also have economic pessimism: There could be a vaccine tomorrow, and the economy still might not recover right away. As we saw in years after the 2008 collapse, economies are like that. If something causes a depression, the depression doesn’t automatically go away once the cause is removed.

So no, the market is not predicting that something wonderful will happen between now and the fall or winter. Maybe it will, but maybe it won’t.

So what are the real reasons the market is so high?

Publicly traded businesses are not typical of the economy. It’s not hard to think of publicly traded companies that are doing badly right now. The big retailers are almost all close to bankruptcy. The real-estate trusts that own the malls are in bad shape. So are the cruise lines, and the hotel chains, and the movie theaters. Even as its new streaming-subscription service is booming, Disney suffers under the twin blows of closed parks and movies it can’t release. And whenever other businesses do badly, banks suffer, because a lot of loans may never be repaid.

But it’s an ill wind that blows no one to good. Lots of businesses are doing OK during the plague, maybe better than ever. Zoom is benefiting from the boom in online meetings. Gilead could have a blockbuster drug in remdesivir. Quest and LabCorp have developed home Covid-19 tests. What’s bad for the gyms is great for Peloton, which pulls isolated stationary-bike riders together into classes or even communities. The money people aren’t spending on restaurants is going to grocery chains like Kroger. What’s killing Macy’s is boosting Amazon. The business models of Google and Facebook are unaffected by the virus. Netflix is well positioned. Stocks like that are up for good reasons.

More ominously, in the long run the big chains stand to benefit if their smaller competitors get wiped out. The family that runs your local diner might go bankrupt, but Denny’s will probably survive. Your barber might lose his shop, but Supercuts will make it. Who knows what will happen to your friendly neighborhood coffee shop, but Starbucks isn’t going anywhere.

The local coffee shop is not on the New York Stock Exchange, but Starbucks is. A lot of the economic pain in the country is happening outside the view of the NYSE. And the demise of businesses off the stock exchange is raising the prospects of the businesses on it.

The Fed Put. For several years, the United States’ single biggest exporter has been Boeing. The aircraft manufacturer employs 161,000 people. The company was already under stress before the pandemic, due to the safety problems of its 737 MAX airliners, which have been grounded for more than a year. And now its main customers, the airlines, can’t fill the planes they have. The maps below — again, click to find a more legible version — show the decline in air traffic between March and April.

But there’s more to that story: “We’re not letting Boeing go out of business,” Trump told Fox News on March 24. The CARES Act included $17 billion that could have been loaned to Boeing.  As it turned out, the company didn’t take the money, choosing instead to float a $25 billion bond issue. But that also might turn out to be government money in a more roundabout way. The bond market is so cooperative because the Federal Reserve, fearing a liquidity crunch, has announced its intention to buy huge quantities of corporate bonds.

And even if Boeing’s money doesn’t come directly from the Fed, wouldn’t you feel more confident owning its bonds, now that you know Trump won’t let the business fail?

I pick out Boeing just for clarity, but it illustrates a wider phenomenon. The Fed has been creating money at a fierce rate, both to cover the federal budget deficit and to prevent a credit crunch or a collapse in demand. Inevitably, some large chunk of that money eventually flows into the investment markets, driving up prices, or at least keeping them from collapsing. Among traders, this is known as “the Fed put” — the belief that the downside risk in the stock market is limited because the Federal Reserve will intervene if things start to collapse.

Interest rates and stock prices (1). But the biggest reason stock prices are as high as they are is interest rates, which are historically low right now. (Again, due to the intervention of the Fed.) It’s practically axiomatic that low interest rates lead to high stock prices.

There are two ways to see that. The first is just simple comparison shopping. Imagine that you’re a big investor. Say you manage the investments of a big pension fund. The model under which your pot of money funds the pensions it’s supposed to cover says that you have to make a certain average return year after year. Let’s make up a number and say it’s 4%. If you average 4% over the next 20 years, the teachers (or whoever) get their pensions and everybody’s happy.

Now imagine interest rates are such that you can buy well-rated 20-year bonds that pay 6%. You’re done. Just buy them and you’ll exceed your goal.

But if you’re in an environment like we see today, a 20-year bond won’t pay much over 1% unless it’s pretty risky. So if you’re going to make your goal, you’re probably going to have to invest in stocks and hope for growth.

When a lot of investors come to that conclusion at the same time, they bid up the price of stocks.

Interest rates and stock prices (2). The second way to see how interest rates affect stocks is more theoretical. In theory, what a stock is worth is the present value of the sum total of all the future earnings per share. The “present value” of $1 of earnings in 2050 — what somebody should be willing to pay today to get $1 in 2050 — is usually quite a bit less than $1. But how much less is determined by the long-term interest rate. What an interest rate is, in essence, is a measure of how the value of money changes through time.  If the long-term interest rate were 0%, that would mean that $1 in 2050 is worth $1 today. At higher rates, that future dollar might only be worth fifty cents today or twenty-five cents or ten cents.

So when interest rates go down, the fundamental value of a stock goes up — even if the economic prospects of the company have not improved.

What investors are thinking. It sometimes comes up on this blog that I buy and sell stocks. I’m far from a tycoon, but my wife and I do have a retirement nest egg that needs to be invested somewhere. So while I don’t operate on the scale of someone who manages a big pension fund or hedge fund, I do go through some of the same thought processes.

And yes, that thinking has to start with the recognition that the economy is historically terrible right now. People disagree about what kind of recovery we can expect over the next year or two, but I expect it to be slow. If the states roll back their lockdown restrictions in a sensible way, we should eventually get to an economy that is just very, very bad rather than apocalyptic. (I think it was Matt Yglesias who imagined a recovery where 80% of the population does 80% of what they used to do. That would still constitute a huge drop in GDP.) If they do it badly (and I think some are), the virus could spike again and start a new lockdown.

At the same time, there will be winners in that world, and we’re all competing to figure out who they will be. For example, I’m betting that most people will continue to pay their phone bills, and that many of them will want to up their data plans. So I own stock in Verizon.

Assuming that you’ve picked a company that will weather the storm, you then have to decide what you think their stock is worth. Is the current price a bargain? Or is it so overvalued that you should sell the stock you own?

And that’s where the question of competing investments comes in. If I sell, what do I do with the money I get? If I leave it in a money market account, it will earn near zero interest. Lots of stocks pay dividends that don’t sound like much by our previous standards, but that look pretty good compared to zero. (Apple currently pays about 1%. Coca-Cola pays 3.5%.) Maybe I wouldn’t buy them if I could get 4% from a CD at my credit union. But I can’t.

On the other hand, maybe the economy’s prospects are even worse than my fellow investors think. (There’s a good chance of that. Investors tend to be professional-class folks or higher up the pyramid. They’re likely to know a lot of people who can work from home and think of the lockdown as an inconvenience. They likely don’t know many people who can’t work and are defaulting on their rent or mortgage. They probably underestimate how many such people there are.) Maybe as we get into summer, the real state of things will filter into the statistics they pay attention to, and we’ll see another crash. In that scenario, I would be happy that I had kept money sitting in a fund paying .01%. Then I could swoop in and buy Apple and Coke at much lower prices (and higher dividend rates).

But back on the first hand, the Fed has created a lot of money, and so have the central banks in other countries. Wherever that money starts out — like the federal government borrowing a bunch of it to send people those $1,200 payments — eventually it’s going to pool up somewhere. And whoever owns that pool is going to want to invest it somewhere. Wouldn’t it make sense to be in the market now, before all that extra money arrives and bids prices up higher?

It’s a conundrum. But on the whole, the lack of competing investments and the fear of missing out pushes me into the market, the same way it pushes a lot of other people. I hold back a little, and I try to be careful about what I buy, but I’m not sitting out.

And that’s why the market is so high.