On Aug.16, the Dow Jones Industrial Average closed the day at 35,625.40 – a record high and an apparent symbol of the pandemic loosening its chokehold on a stock market dealing with uncertainty in all industries. The milestone marked a stark contrast from March 2020 when the pandemic first entered the public’s consciousness. The market […]
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On Aug.16, the Dow Jones Industrial Average closed the day at 35,625.40 – a record high and an apparent symbol of the pandemic loosening its chokehold on a stock market dealing with uncertainty in all industries.
The milestone marked a stark contrast from March 2020 when the pandemic first entered the public’s consciousness. The market on March 11 finished the day down 20% from just one month earlier in February. But the market recovered, gaining more than 11,000 points to reach the record high set this past August. The recovery, after a virtual standstill during the height of the pandemic, was the fastest in U.S. market history.
“We saw a massive contraction of the economy, which turned out to be the second largest decrease in GDP since the Great Depression,” said Ashish Tiwari, a Henry B. Tippie Research Professor of Finance at the University of Iowa. “Unemployment rates were the highest we’ve seen in modern times. The recession itself was actually fairly short, lasting through April. They tend to be much longer in duration.”
The reason, Mr. Tiwari says, is multi-faceted and ties back to lessons learned from the 2008 financial crisis.
“There was an injection of liquidity in the market this time around,” he said. “The provision of direct aid to consumers was a signal to investors that the liquidity crisis we saw in 2008 wouldn’t repeat this time around.”
Those steps to avoid a collapse included a range of actions, including three rounds of checks to qualified individuals, an extension of unemployment benefits, a moratorium on evictions from rental properties and a direct provision of funding to businesses through the Paycheck Protection Program.
“But above all, there was a massive injection of liquidity by virtue of the Federal Reserve engaging in quantitative easing,” he added.
Quantitative easing is the synthetic purchase of assets like treasuries, mortgage-backed securities, and corporate and municipal bonds.
The Fed also lowered its target federal funds rate to near zero, essentially making lending a lot cheaper. This affects the rate at which banks borrow from each other, ultimately filtering down to the end consumer.
“So all of those steps meant that we ended up establishing a floor for valuations, and investors, I suppose, perceived this,” Mr. Tiwari explained.
Disconnect with small businesses
Although the financial side of the economy, or the stock market, bounced back – and then some – small businesses haven’t necessarily felt the impact of recovery and are concerned about economic issues outside the stock market’s control, said Peter Alepra, senior vice president and branch director of RBC Management, Cedar Rapids.
“There’s a lot of low-cost money out there still on the sidelines that has to be, or will be, deployed somewhere that will be inflationary,” he said. “This problem extends into other areas as well. You see a pretty critical demand for workers, so to entice people to work, wages must go up, which is another example of inflation.”
Other uncertainties that could cause skepticism include an overall low vaccination rate nationally and difficulty obtaining raw materials, said Kate Moreland, the Iowa City Area Development Group president. However, she also notes that many of the problems businesses face today are more severe to small businesses than large corporations.
“Large companies have had an advantage during this shock,” said Tong Yao, professor of finance at the Tippie College of Business. “Small retail shops may have had to close down because they are short-staffed and their supply chain got disrupted, but Walmart is able to manage its own supply chain very well, and they can provide certain kinds of insurance to their employees. Technology companies that are not consumer-facing, like Amazon, Google, or Facebook, also do quite well since virtual economies don’t tend to suffer as much.”
“There’s a clear detachment, or a disconnect, between the stock market and the problems small businesses face,” Mr. Yao added.
Measuring financial long-term impacts
It may seem counterintuitive that the stock market is not a great indicator of the economy’s health for the casual observer, but that is often the case since it measures something else entirely.
“The best way to think about the stock market is to view it as anticipated future earnings from the business in the economy from publicly traded companies,” said Mr. Tiwari. “So really, it’s the present value of a potentially very long-term, almost infinite string of earnings.”
In simplistic terms, this allows investors to approach the stock market with a very different mindset than a small business owner who must keep the company afloat each day, even when a stock market dip can still have real consequences on the daily operations of a business.
Counteracting market volatility is not easy for business owners because their equity is in the business itself, said Mr. Alepra. “A lot of times, their mentality is they’d rather put money back into the business so they can control it, as opposed to taking excess cash and putting it in the stock market.”
He explained that the average person’s wealth management plan should vary based on the individual’s time horizon. For example, some people can take a long-term approach to the market, knowing that specific sectors of the economy are highly likely to grow. At the same time, older folks nearing retirement have a shorter time horizon and don’t have the appetite for the fluctuation of their portfolio.
Managing critical issues
Given the current state of the global economy and the roller coaster-like nature of the stock market, what is the outlook for the region and the country?
Specific issues could derail the current upswing, including a natural decline that would inadvertently allow the economy to “take a bit of a breather” from its historic climb, said Mr. Alepra. Other problems could stem from continued inflation or government inaction that turns critical economic policy, like the debt ceiling debate, into a toxic “political football.”
Government rulings on antitrust lawsuits could also have a significant impact on mega-corporations such as Facebook and Google. In addition, how the Federal Reserve chooses to modify their economic policy is sure to cause many side effects, and trade policy with China will all likely play a role in the stock market’s health in the next 12 months, explained Mr. Yao.
While concerns that arise from complex issues will always remain, there’s reason to be optimistic, too.
“I think the situation is positive,” said Mr. Alepra. “Hopefully, when thinking about the pandemic, the next six months are better than the past six months. If that’s the case, that should be beneficial to the economy and the markets.”
“I think, truly, that the most critical thing for every person is to have a diversified wealth plan that is customized to their needs and comfort level, whether they are 22 or 65,” he added.
