Crashing Economy, Rising Stocks: What’s Going On?

What’s bad for America is sometimes good for the market.

Paul Krugman
April 30, 2020
The economic news has been terrible. Never mind Wednesday’s G.D.P. report for the first
quarter. An economy contracting at an annual rate of almost 5 percent would have been
considered very bad in normal times, but this report only captured the first few drops of a
torrential downpour. More timely data show an economy falling off a cliff. The Congressional
Budget Office is projecting an unemployment rate of 16 percent later this year, and that may well
be an underestimate.
Yet stock prices, which fell in the first few weeks of the Covid-19 crisis, have made up much of
those losses. They’re currently more or less back to where they were last fall, when all the talk
was about how well the economy was doing. What’s going on?
Well, whenever you consider the economic implications of stock prices, you want to remember
three rules. First, the stock market is not the economy. Second, the stock market is not the
economy. Third, the stock market is not the economy.
That is, the relationship between stock performance — largely driven by the oscillation between
greed and fear — and real economic growth has always been somewhere between loose and
nonexistent. Back in the 1960s the great economist Paul Samuelson famously quipped that the
market had predicted nine of the past five recessions.
But I’d argue that there are deeper reasons for the current stock market-real economy
disconnect: Investors are buying stocks in part because they have nowhere else to go. In fact,
there’s a sense in which stocks are strong precisely because the economy as a whole is so weak.
What, after all, is the main alternative to investing in stocks? Buying bonds. Yet these days
bonds offer incredibly low returns. The interest rate on 10-year U.S. government bonds is only
0.6 percent, down from more than 3 percent in late 2018. If you want bonds that are protected
against future inflation, their yield is minus half a percent.
So buying stock in companies that are still profitable despite the Covid-19 recession looks pretty
attractive.
And why are interest rates so low? Because the bond market expects the economy to be
depressed for years to come, and believes that the Federal Reserve will continue pursuing easy-
money policies for the foreseeable future. As I said, there’s a sense in which stocks are strong
precisely because the real economy is weak.
Now, one question you might ask is why, if economic weakness is if anything good for stocks, the
market briefly plunged earlier this year. The answer is that for a few weeks in March the world
teetered on the edge of a 2008-type financial crisis, which caused investors to flee everything
with the slightest hint of risk.
That crisis was, however, averted thanks to extremely aggressive actions by the Fed, which
stepped in to buy an unprecedented volume and range of assets. Without those actions, we
would be facing an even bigger economic catastrophe.
Which is, by the way, one reason you should be concerned about Donald Trump’s attempts to
appoint unqualified loyalists, with a history of supporting crank economic doctrines, to the
Federal Reserve Board. Imagine where we’d be now if the Fed had responded to a looming
financial crisis the way the Trump administration responded to a looming pandemic.
But back to the disconnect between stocks and economic reality. It turns out that this is a long-
term phenomenon, dating back at least to the mid-2000s.
Think about all the negative things we’ve learned about the modern economy since, say, 2007.
We’ve learned that advanced economies are much less stable, much more subject to periodic
crises, than almost anyone believed possible.
Productivity growth has slumped, showing that the information technology-fueled boom of the
1990s and early 2000s was a one-shot affair. Overall economic performance has been much
worse than most observers expected around 15 years ago.
Stocks, however, have done very well. On the eve of the Covid crisis, the ratio of market
capitalization to G.D.P. — Warren Buffett’s favorite measure — was well above its 2007 level,
and a bit higher than its peak during the dot-com bubble. Why?
The main answer, surely, is to consider the alternative. While employment eventually recovered
from the Great Recession, that recovery was achieved only thanks to historically low interest
rates. The need for low rates was an indication of underlying economic weakness: businesses
seemed reluctant to invest despite high profits, often preferring to buy back their own stock. But
low rates were good for stock prices.
Did I mention that the stock market is not the economy?
None of this should be taken as a statement that current market valuations are exactly right. My
gut sense is that investors are too eager to seize on good news; but the truth is that I have no
idea where the market is headed.
The point, instead, is that the market’s resilience does, in fact, make some sense despite the
terrible economic news — and by the same token does nothing to make that news less terrible.
Pay no attention to the Dow; keep your eyes on those disappearing jobs.