The Pandemic and the Stock Market

The behavior of the stock market has been a great puzzle to most observers lately. Why is the market surging when the economy is still struggling, unemployment is still high, earnings have sunk, and the pandemic still rages?

Stock values are substantially pinned to forward prospects and interest rates, not what is happening today. (Note I say “substantially” – that’s because certain events, like the attack on the World Trade Center and the early shutdowns due to the pandemic cause the market’s viewpoint to shorten momentarily; that’s when you get that sinking feeling…. )

Interest rates are benign at the moment, boosting stock values. A simple way to think about this is in terms of dividend yields. The average dividend in the stock market today is somewhere close to 2%. But the long Treasury yields less than that. Some investors will prefer the higher cash flow, even with increased risk, on stocks. Dividends do go up over time, too. The more complicated answer is that a formula called the dividend discount model shows that stock values increase when bond yields decline.

Aside from the math, another reason stocks are rising is because companies are cutting expenses right and left. When people return to whatever purchasing becomes normal after the pandemic, new sales revenue will go nearly straight to the bottom line, generating much higher cash flows and profits in out years. Investors are looking forward to those improved earnings streams. And that is what’s causing today’s prices to ignore today’s economic fallout.