The stock market is off the rails

To investors, it makes sense. Stocks have surged 40% since late March because the worst damage from the coronavirus recession is in the past and the cavalry has arrived. The Federal Reserve is now propping up risky assets, Congress is flooding the economy with money and there are wee signs of an economic recovery.

If you’re an ordinary person who thinks the soaring stock market is crazy, you’re right. There’s no right or wrong value for any stock, or for the market as a whole. There’s only the value the market assigns at any point in time, based on supply, demand and other factors. But demand for stocks—investors placing buy orders—is wildly out of sync with what’s happening in the real economy, where 42 million Americans are newly unemployed and millions of businesses are reeling.

Traders are right when they say the stock market evaluates the future, not the past. Backward-looking economic data about what happened last week or last month is irrelevant to the value of stocks unless it hints at future actions, such as an unexpected change in Federal Reserve policy. But it’s hard to imagine what future stocks are evaluating right now. 2025? 2030?  If so, that’s a time horizon so distant it’s almost meaningless.

Here are some of the grim developments economists foresee during the next 12 to 24 months:

Massive small business failures. “Very small businesses with just a few em­ployees are expected to fail en masse,” Moody’s Analytics says in a June 2 forecast. “Of the 8 million busi­ness establishments operating prior to the crisis in the U.S., it would not be surprising if close to a million do not make it. New busi­nesses will eventually form, and the economy will recover, but that process will take years, not months.” Many of those small firms don’t have the connection with banks needed to take advantage of federal aid. Commercial bankruptcy filings in May soared by 48% year over year, a preview of the carnage coming.

There have been over 42 million jobless claims amid the coronavirus pandemic. (Graphic: David Foster/Yahoo Finance)

Trillions in lost output. The Congressional Budget Office estimates the coronavirus recession will cost the U.S. economy $15.7 trillion in real economic output by 2030, adjusted for inflation, for a 5.3% drop in total output. That’s 7 months’ worth of economic activity that simply won’t happen, which will suppress employment and incomes well into the decade.

A long and slow jobs recovery. IHS Markit thinks employment won’t recover to pre-virus levels until 2024. That’s four years from now. Congress is already hesitant to pass a fourth stimulus bill, because of the massive run-up in federal debt stimulus measures have already caused. Will it be willing to add even more debt a year from now? Two years from now?

Debt crises. Governments everywhere are racking up debt to bail out companies and workers and keep the global recession from getting worse. At some point, serious doubts will rise about some countries’ ability to make interest payments. It’ll happen first in developing countries and then perhaps in Italy. Rising interest rates would be one ugly manifestation, pushing up borrowing costs for everybody.

Bank stress. Many businesses that fail or restructure will default on debt owed to banks and other lenders. Banks aren’t fragile and overleveraged as they were before the financial crash in 2008, but an unforeseen shock of the magnitude we’re seeing now could bring down at least a few lenders.

Investors clearly think the Fed and other central banks can corral these problems, and the Fed certainly has the power to massively intervene in the economy. What the Fed can’t do, however, is create demand. That requires businesses and consumers to gain confidence that the coronavirus is gone for good, jobs are safe and it’s okay to spend money.

In this March 3, 2020 file photo, Federal Reserve Chair Jerome Powell speaks during a news conference to discuss an announcement from the Federal Open Market Committee, in Washington. (AP Photo/Jacquelyn Martin)

Most states are now easing stay-home restrictions meant to stop the spread of the virus, and economic activity is slowly bouncing back in some places. But job losses, business closures and lost spending are also causing structural damage to the economy that will take years to repair.

Those lost jobs and businesses do matter to the stock market, because they impact profitability at many publicly held companies, and solvency at a few of them. But the power of the Fed outweighs all of that, or at least investors think it does. “Unprecedented support from central banks has helped prevent the vast economic shock caused by the virus from morphing into a financial crisis,” Capital Economics explained to clients on June 4. “We think that many risky assets could keep outperforming.”

So a buoyant stock market makes no sense in relation to the devastation occurring in the real world. But it makes perfect sense given the Fed and other central banks are pushing stocks up, to rebuild confidence in one slice of the economy. Whether you’re incredulous at the stock market’s performance, or cheering it on, you’re right.

Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. Confidential tip line: [email protected]Encrypted communication available. Click here to get Rick’s stories by email.

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