Infections from COVID-19 have continued growing. Moreover, respondents between June 29 and July 5 from a recent Gallup poll show that roughly 68 percent of the population believes the coronavirus situation is getting worse, whereas 18 percent thinks it is getting better. That’s reverse from June 1 to 7 when 47 percent reported that the situation was getting better and only 30 percent said that it was getting worse.
Why, then, has the stock market continued growing? Admittedly, the Federal Reserve has injected a lot of liquidity into the economy, which is not necessarily a good thing for our long-run prospects, but that’s a separate story—see Fragile by Design by Professors Charlie Calomiris and Stephen Haber.
Instead, consider two additional factors that seem to be driving the recent stock market growth.
Smashing Expectations
First, employment has increased a lot more than anticipated. For example, while nonfarm payrolls were suppose to only increase by 2.9 million in June, they actually increased by 4.8 million. Moreover, retail sales surged by 17.7 percent in May, which beat the 8 percent forecast. Even though infections are up from May, the expectation was never that they were going to flatten completely—the purpose of the national quarantine in April and part of May was to flatten the curve.
In ongoing research using data from HomeBase, a scheduling and payroll tracking platform for small businesses, my coauthors and I found that the reopening led to a 26 percent rise in working hours for retail, hospitality, and food/drink establishments. While the increase in employment has not full offset the original decline, we’re off to a very strong start—beating back many of the pessimistic expectations from academics and the media.
Reducing Supply Chain Risk
Second, hospitals are no where near as crowded and overwhelmed now, relative to the peek in April, although some media outlets have offered a different perspective. Thanks to a significant amount of work by the White House to coordinate the delivery of personal protective equipment (PPE) and strengthen supply chains, hospitals are more prepared to accommodate an influx of patients. If that were not the case, then hospitals would be refusing elective surgeries.
A big worry for for Wall Street in April was the supply constraints in hospitals, which created massive uncertainty and the potential for a system-wide failure. However, now that we know a lot more about the spread of the virus, the effectiveness of mitigation activities, the death rate, and have a stronger supply chain, there is much less for the market to worry about. There is much more to continue learning and the situation is changing, but our health infrastructure has nonetheless been significantly upgraded.
Sentiment Matters
Even though infections have continued growing, economic sentiment surged in June, relative to April and May. For example, according to the Conference Board, the Confidence Index increased to 98.1 (1985=100) in June, up from 85.9 in May. Moreover, the Present Situation Index grew from 68.4 in May to 86.2 in June. And, the Expectations Index rose from 97.6 in May to 106.0 in June.
A huge part of the way that people form expectations about the economy is through personal experience. So, if everything is closed, as it was in April and much of May, then people are naturally going to be more afraid. But, as the economy began opening up, people begin getting use to the new federal and state guidelines, allowing optimism to return to trend.
For example, in a recently published paper in the Review of Economics and Statistics, my coauthor and I investigate how fluctuations in gasoline prices affect expectations about the economy. We found that increases in state gasoline prices make consumers more pessimistic about the state of the national economy… even though gasoline prices have little predictive power of macroeconomic activity! Furthermore, we found that these effects were concentrated in areas where people are more likely to commute and where gasoline prices are already high, relative to the national average.
In this sense, the continued growth in the stock market should not be seen as an anomaly—it’s a rationale response to the revelation of new information. And, people are responding to that information by becoming increasingly optimistic.
If we want to maintain the economic recovery, we should pursue middle-of-the-road policies, like wearing masks, and allow for decentralized responses that treat counties differently based on their unique situation and composition. Indeed, my research finds that the more restrictive policies, such as stay-at-home orders and non-essential business closures, have had severe adverse effects on employment, especially the childcare market, with limited long-term health benefits.