Much commentary has been made – often incredulous, outraged, or both – about the “disconnect” between the stock market, which has roared back from the steep, historic sell-off in late February and March not only to erase virtually all of that drop but also to propel many stocks to new all-time highs, and the general state of affairs in the world, particularly in the United States, that appears as dire as it has been in decades. Even the crudest inventory of what is ailing the U.S. at the moment would note: more than 100,000 lives lost to the COVID-19 pandemic; 20 million jobs lost as a result of the unprecedented shutdown of economic activities in an attempt to contain the pandemic which likely has already plunged the economy into the steepest recession since the Great Depression; a strained relationship with China, its largest trading partner, that continues to spiral downward as we not only saw no meaningful progress out of the so-called “phase 1” trade deal reached in 2019 but now have the President of the U.S. openly accusing China for the spread of the pandemic; and racial discontent and tensions that have boiled over to manifest as protests and riots in cities small and large all over the country after years of high-profile cases of police brutality resulting in deaths of African Americans yet seemingly leading to no tangible changes of any kind, in policies, politics or the broader culture.
At this particular moment, the future looks as uncertain and bleak as we have seen it, yet the stock market, which just recorded the greatest 50-day rally ever in history, doesn’t seem to reflect this reality at all. The stock market, many believe, is a “discounting” mechanism, which takes all available information about what is knowable about the future and elegantly expresses its calculated probability outcomes as price levels. Given this view, the stock market of today seems broken and its pricing actions completely divorced from what is plainly observable to most about the present reality. Befuddlement, even indignation, particularly given the juxtaposition between the plights of low-income wage earners who have been subjected to the brunt of the current economic malaise, and the ever-soaring stock market, which disproportionately benefits the wealthy, is understandable.
Yet the stock market, I would argue, is no such mechanistic machinery of discernible inputs and expected outputs. Nor is it a sentient being that has any understanding of how human beings perceive reality or is compelled to reflect that reality in any way. The most important word in the phrase “stock market” is “market” – it is a marketplace of buyers and sellers, in which the prevailing price is dictated by supply and demand. Thus viewed, the stock market does not go up on any given day because the future looks particularly brighter compared to the preceding day and the market accordingly incorporates that view in its pricing mechanism – the future looking particularly brighter to some humans and the stock market going up on that same day may be coincidental, but one does not directly cause the other. Rather, the stock market goes up because, in the aggregate, demand exceeds supply and there is marginally greater buying pressure than selling pressure. The buyers may even be buying because they believe the future is looking brighter that day, but every transaction that takes place has a seller as well as a buyer, and a genuine seller who is not merely a market maker would not be selling out of an agreement with the buyer on any claim about the future. The real reason why demand overall happens to exceed supply on a day the stock market goes up, in most cases, is unknown, and, I would even argue, unknowable, despite the seemingly persuasive narratives spun out by financial press on a daily basis.
This is not to say there are not larger undercurrents that affect the trends in the stock market that are intelligible to us. The initial sell-off earlier this year certainly was precipitated by the prospects of a recession caused by the pandemic-induced economic shutdown. The subsequent rebound almost certainly was a result primarily of the massive liquidity injection by the Federal Reserve, as well as its unprecedented move of purchasing corporate bonds for the first time in its history, thereby lowering the required risk premium in equities by a great margin. But the path from these macroeconomic forces to the day-to-day price movement of the stock market is a long and winding one, and there almost always is not a direct and immediate causal connection. Instead, individuals buyers and sellers enter into transactions for a myriad of reasons and the only thing that is clearly discernible is the movement of the prices themselves.
The stock market, in the end, is nothing more than an aggregation of participants buying and selling in a marketplace. It does not render a verdict on the economy, foretell the prospects of future prosperity or decline, or hand down a judgment on how we’re doing as a society. It is as blind as the blindest of us of what the future holds, and is a woefully inadequate lens through which to evaluate where we are today or where we are headed tomorrow.