Last week, the U.S. Department of Labour reported the highest number of initial jobless claims ever at 3.28 million. For some perspective, the highest this economic indicator has ever been was 665,000 in March of 2009.
On the face of it, this news should have caused investors to panic and for stocks to sell off sharply. Instead, the S&P 500 ended the day up more than 6%. What could possibly explain this apparent paradox? Let’s dig in.
A multi-layered explanation
There are a number of layers to this apparent paradox. The first layer is that not all news is really news. There were plenty of market participants that had estimated that the unemployment numbers could be that bad (even though the average forecast was more in the 1.6 million range), because there are plenty of smart people with research departments that are able to collate the data on a state level and arrive at a reasonable forecast for a lot of economic data.
The second layer is the "it wasn’t as bad as we expected" argument. Even though last week’s print was five times worse than the previous record, markets seem to have priced in a more apocalyptic scenario. It’s very difficult to know in advance what the actual expected number is - this is something that can only really be determined after the fact. But in this case at least, it seems like expectations were much lower.
A third explanation is that this news itself was a passive catalyst for an overdue market rally. Think back to a few weeks ago, when the stock market was in freefall. The general mood during such times is one of panic, meaning that no one really has a good idea of what "fair value" is. Consequently, prices may have fallen significantly more, and after having some time to reassess, investors were just looking for any reason to correct.
The fourth, and I think the most interesting, layer of this explanation is that markets are fundamentally forward looking. They are a leading indicator for the real economy, not the other way around. This is why major stock indices started crashing in early March, way before businesses started experiencing cash flow problems (but after it became apparent that they would do so down the line). Now that this has happened, investors are looking beyond what is happening right now and trying to position themselves for the latter half of the year.
What does this mean for investors?
I know that many people believe that the market is still in denial about the economic damage that will be wrought by the novel coronavirus and the associated lockdowns. My personal view is that we are currently pricing in a lot more unemployment than has been officially reported. I don’t believe that markets are always efficient, but I do think that they are efficient a lot of the time. I don’t think that most money managers would be surprised if unemployment hits 25-30% over the next few months or so.
The Federal Reserve estimates that unemployment levels will reach 32%. Goldman Sachs (GS) estimates a 15% unemployment rate and a 34% decline in U.S. GDP. Other major financial institutions have similar forecasts. It seems odd to suggest that these expectations are not at least somewhat baked into stock prices.
I’m not saying that things won’t get worse. That same Goldman Sachs report estimates that the third quarter of 2020 will see a record rebound in economic activity. This might well turn out to be overly rosy. Nor am I saying that we won’t see new lows in the stock market.
What I am saying is that the market usually looks beyond what is happening in the here and now, so don’t be surprised if it seems to act in counterintuitive ways - it’s more than possible that we will see more rises off the back of bad news.
Disclosure: The author owns no stocks mentioned.
Read more here:
- The Problem With Social Trading and Blindly Following
- Why Regulators Shouldn't Close the Stock Market
- Why Has the Shadow Banking Sector Become a Problem?
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