What Happened This Week (10/23/2020)

The market's turnaround and push to new highs at a time when so much economic output has yet to recover is redefining their historic relationship. A fair question to ask--could this repeat in the not-to-distant future, but next time could the economy flourish while the stock market falters?

The stock market has disconnected from the underlying real economy to an extent never before experienced in the modern era (Source: The Daily Shot). While it is normal for the market to be “out in front” of the economy, we’ve never seen negative correlation between the two as measured above—a deep economic struggle at a time when stocks soar.

This coming Thursday, we will see the advance estimate of 3rd quarter GDP (reported at a seasonally adjusted annual rate, or SAAR). The Atlanta Fed’s GDPNow estimate stands at 35% (about 7.8% QoQ). If the forecast proves accurate, this phenomenal level of growth will leave the US economy at 96.7% of the pre-Covid level of economic activity, according to Bill McBride of Calculated Risk. To put the gap in perspective, that’s about the same level coming out of the ’08-’09 recession that was reached in early 2010. Positive steps for sure, but much work is left to be done, given the depth of the fallout.Within the S&P 500, the largest companies have the loudest voices. Many of these market leaders throughout Covid have seen their stock prices skyrocket, given their tremendous profitability and dynamism. Six months into the “new” bull market, however, returns on the market are in line with the 2009 recovery (44.7% thus far compared to 52.7% in 2009). What is surprising about today’s experience is the elevated valuation metrics reached by the cap-weighted index this early in the recovery. According to a recent study by The Leuthold Group, “the S&P 500 P/E is trading at 29.6x, a reading that’s 30% higher than at the same point of any other bull market—and almost double the average reading going back to 1932.” This leaves another negative correlation for investors to deal with—negative prospective returns on the largest stocks over the next decade. This could lead to an environment where the economy flourishes, even if the market falters.