Coronavirus, The Stock Market, And The Economy

Many people have become very concerned about the economy because of the stock market’s plunge in the last two weeks. While the spread of the coronavirus gives us very good reason to worry about the state of the economy, the plunge in the stock market does not. In fact, those folks who are very concerned about wealth inequality can celebrate because the wealth of the top 1 percent has just dropped by around 10 percent, while the wealth of the bottom 50 percent has barely been touched. (I tend to focus on income inequality, in large part for this reason.)

Anyhow, the stock market does not generally provide us with very good insight into the future of the economy, except when it looks like more of the same. It’s sort of like hearing the weather forecaster tell you it’s sunny, as you step outside into the sunlight. You didn’t really need them for this purpose. When it comes to telling about the storm just around the corner, the stock market is a much worse predictor than weather forecasters.

We don’t have to look to ancient history to see this point. In October of 2007, the S&P 500 hit what was at the time a record high. That was less than two months before the beginning of the worst recession since the Great Depression. The stock market did not give us much warning on that one.

As I noted last week, the run-up in the stock market in the last few years had pushed price-to-earnings ratios to unusually high levels. I did not argue that this necessarily implied a market plunge, but I did point out that as a matter of logic, high price-to-earnings ratios virtually guarantee low returns in the future. For this reason, a sharp market downturn should not be a surprise, even if the specific cause is.

If the stock market is not a very good predictor of the economy’s future, it is also not generally a causal factor. There is a sort of fairy tale story that a high stock market is good for the economy because it means that companies can effectively borrow cheaply by issuing new shares. In this fairy tale, that means that they can more easily raise money for investment, which means more growth and higher productivity and wages.

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Charles Howard 1 year ago Member's comment

Dean Baker It’s been a rollercoaster market in recent days for equity investors, and today we appear to be on the downward leg for that ride.

Gary Anderson 1 year ago Contributor's comment

Well, it is in Maryland now. It will eventually hit DC and we will see if Trump gets more serious.