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Several of our users, professional investors, and to my surprise, venture capitalists and angel investors that I deal with are surprised by the unprecedented and unique upward movement of the stock market prices compared to the grim state of the economic outlook. For example, within our private user community, The Intelligent Stock Market Investors group, almost every day, we go through heated discussions about the irrational exuberance of the so-called perma-bulls and the doom and gloom view of the future by the more rational bears of the community. Who is on the right side of the debate? Is the dichotomy of eroding economy and growing stock market as surprising as it appears? I have been reading voraciously and reflecting on the arguments shared by both sides of the aisle. From clicking on Howard Marks' memos as soon as they land in my inbox, to venturing into the deep end of historical data, and re-listening to Nasim Taleb's Blackswan for the gazillionth time, I now have a few takeaways to share with our community.
Are we living in an unprecedented time?
No, we are not! My Dad was telling me about the malaria outbreak when he was a young man. He clearly remembers government officials visiting their house and spraying every nook and corner of the yard, even in the most rural areas. The vivid pictures he drew in my mind resembled the scenes from social media, showing vigorous disinfecting of the BART cars and buses in the Bay Area. My Dad's childhood stories were complemented by the diaries of Benjamin Roth from the Great Depression era. Roth was a lawyer living in Youngstown during that time and took detailed notes on the state of the society, the job market, and the stock market as he lived through the 1930s and the ensuing decades. The COVID-19 pandemic is nothing new. It does have its unique characteristics such as the minute by minute media coverage of the death toll. Still, not even the wearing of facemask is a new social experience unique to the COVID-19 era. The below photo is courtesy of nytimes.com and shows women wearing masks during the 1918 flu pandemic in NYC.
Is the stock market being uniquely and unprecedently irrational?
No, the stock market's upward movement is not a new phenomenon unique to the COVID-19 pandemic's impact on the stock market. The stock market has always been irrational. The dichotomy of declining economic output and upward stock prices is nothing new and rather common in the history of the stock market. The confusion comes from the widespread assumption that the stock market follows some economic theory and is bound by the mathematical models we economists tend to use to explain the market's movement. The stock market has nothing to do with the modern economic theories, neither does it follow a perfect cycle of boom and bust. John Templeton had put it the best in his letter to his clients in 1958 when the Dow index rose from 257 to 343 in a matter of a few months while the industrial production declined from 137 to 123, during the same time period.
Is there no reason for the stock market to go up when the economy goes down?
Of course, there is. If all other factors were equal, stock prices might move in the same direction as the economic output. However, the stock market is influenced by a variety of factors, including the overall market sentiment and investors' expectations for the future output of the economy compared to the current prices. The stock market prices have been going up for the same reason as the stock price of a nearly-bankrupt company jumps double-digit in one day. More important than the impact of sentiment and exceptions is the "market" nature of the stock market. As in any market, when there is more demand than supply, it pushes the prices up. When there is idle cash sitting around, exacerbated by historically low to zero interest rate, money pours in.
There is no point in being bullish or bearish about the stock market. There is no absolute bullishness or bearishness. Even in the most bearish of environments, you can find bullish movements and opportunities and vice versa. Instead of debating to nausea that the market is going to go down or fly to the sky, the goal should be to step back away from the frenzy and look for the opportunities that reveal themselves.
The two books mentioned in this blog post are: