The stock market recovery has caused many economists and professional investors to scratch their collective heads. Many question how the stock market can rally in the face of an economic recession, continued uncertainty about the health risks from reopening the economy, and questions about future consumer behavior in a world where normal consumer behavior may increase the risk of contracting the Coronavirus. Some have noted that the US stock market is down just 8% from its February high and down 4% from the beginning of the year whereas economic activity may have decreased by far more.
There are several themes at play. The first is that the economy and stock market typically recover very quickly from event-driven recessions. Therefore, the stock market may be looking forward several quarters and anticipating a speedy economic recovery which may support stock prices. It is also common for the announcement of a recession to coincide with a bottom in the stock market. In other words, by the time the economic data deteriorates to the point that the National Bureau of Economic Research declares the US economy to have entered a recession the economy has often bottomed. Therefore, buying stocks after a recession has been declared can be a good strategy. So, despite the poor data that has been reported, many investors may believe that the worst is behind us.
Then there is the question of how the stock market could rally when the nation is dealing with social unrest. News images of people protesting in the streets have led to concern that there may be a second surge in Coronavirus cases. Yet, this also could be interpreted as a positive sign for the economy. It shows that people are willing to accept the risk of contracting the virus. In other words, fear of the virus may be subsiding which may mean that consumers will also return to their normal behavior as businesses are able to reopen.
Historically, event-driven recessions have resulted in pent-up demand. As a result, economic activity often rebounds significantly once the initial fear stage subsides. This pent-up demand may create an opportunity for businesses that are able to innovate and find ways to attract new customers despite the restrictions that remain in place. For this reason, many investors may be anticipating a strong rebound in consumer activity once the economy is able to reopen and consumer’s fears subside. This pattern is evident in the May retail sales report which showed a strong rebound in consumer spending, especially at brick and mortar establishments.
The US economy has been forced to deal with a number of event-driven recessions in the past. The causes of these recessions range from wars to terrorist attacks to health risks. In each case the economy has rebounded fairly quickly and robustly with the economic growth rate returning to its trend rate within a year. The current challenge no doubt brings a unique set of issues and risks that must be addressed which does create a high level of uncertainty about the future. Given this uncertainty, many investors realize that it is impossible to accurately forecast the path that the US economy will take going forward. Absent the data needed to accurately assess the impact of the current risks many are relying heavily on historical comparisons. These historical comparisons support the bull case that the US market and economy will recover fairly quickly. However, it is still important to monitor current events, economic reports, and health data to determine if the current crisis is following the historical pattern or deviating from past trends.