The US economy and the stock market are the most out of whack since the dot-com bubble

Buy the dip.
Buy the dip.
Image: Reuters/Andrew Kelly
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The world’s biggest economy is projected to crater this quarter, in what is likely to be the largest contraction since at least the Great Depression. US stocks, meanwhile, have soared. They’ve recouped trillions of dollars of market value in recent weeks, erasing a swoon in March as commerce was forced to shut down around the world.

If forecasts for a 30% to 40% decline in gross domestic product turn out to be accurate, then the US stock market’s valuation is more disjointed from the underlying economy than it’s been since the dot-com bubble in 2000. The Federal Reserve’s Nowcast, a statistical model based on economic indicators, forecasts a 31% contraction in GDP, while economists at JPMorgan estimate the economy could shrink as much as 40%.

The market capitalization of the companies in the S&P 500 Index, a benchmark that tracks 500 large US-listed stocks, is defying gravity. Investors are looking past the economy’s downtown, anticipating a time when growth rekindles. If JPMorgan’s estimates are accurate, the S&P 500 will soon be worth about 25% more than US GDP, assuming the stock market remains close to its value at the end of April 2020. The ratio of stock market capitalization to GDP is sometimes called the Buffett indicator, named after investor Warren Buffett who has used it to analyze whether the stock market is overvalued.


“The S&P 500 is essentially the collective wisdom of the market, evaluating whether it thinks the economy will be in a better position, say, four to six months down the road,” said Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research. “Obviously this recession—you could call it a depression—is different than anything we’ve experienced in the past. It’s a government mandated recession, which has never happened.”

There are reasons to be wary of these stock market valuations. The economic picture is so uncertain that many corporate executives have suspended making earnings guidance, leaving stock analysts with less data to work with. The future path of the pandemic is also uncertain. As some economies around the world re-open, virus breakouts may reoccur. It’s unclear when, if ever, there will be a vaccine. Given so many uncertainties, the US stock market’s steadfastness is somewhat surprising.

“We’re trying to force the new rules to fit into the old model and they just don’t work,” Frederick added. “The word ‘unprecedented‘ is the most overused term there is right now, but there’s no better descriptor.”

However, there are several factors that could be underpinning the S&P’s rally. The US government has pledged more than $2 trillion of support for workers and industries. And the Federal Reserve has cranked up a series of programs to keep financial markets operational. As part of those efforts, the central bank is buying trillions of dollars of assets, including corporate bonds, to prevent the financial system from freezing up. The Fed’s buying spree reduced interest rates and is driving investors to take more risk.

“We have such massive fiscal and monetary intervention,” Frederick said. ”In the absence of government intervention, the markets would be off a cliff.”