Why Is The S&P 500 Not Matching U.S. Economic Weakness? Here Are Three Reasons


One of the surprising things about our current situation is how weak unemployment is based on current data, as some estimates have it heading over 20%. In contrast the S&P 500 is now up over 25% from late March lows, while weak data keep rolling in and a U.S. recession potentially deepens. Can the markets and the economy be reconciled?

Sector Weights

It’s important to note how the different companies in the S&P 500 are weighted. Technology, communications and healthcare stocks now represent just under half the index. As a rule those companies are feeling the impact of COVD-19 less at this point, are even benefiting in some cases.

Tech is dominant in the S&P 500. Three companies, Apple

AAPL
, Microsoft

MSFT
and Amazon

AMZN
, make up more than 15% of the S&P 500’s value. That makes those names alone worth more than five times the value of every single energy company in the S&P 500, or almost double the value of every industrial company.

As a result, indices such as the S&P 500 are benefiting from the rise of tech stocks, which have held up far better than other companies during the COVD-19 crisis. As a point of reference the tech-heavy Nasdaq

NDAQ
index is now broadly flat for 2020 as a whole. Therefore, on its current composition, the S&P 500 is far more sensitive to moves in the tech sector than having a real pulse on other sectors of the economy like energy and manufacturing. This is because tech stocks make up almost a quarter of the S&P 500, while they represent a much smaller proportion of the U.S. economy. The reverse is true of other sectors hit far harder economically such as energy, manufacturing, financial services and retail.

International Exposure

The S&P 500 increasingly contains a set of international businesses. Yes, they are listed and generally headquartered in the U.S. but sales are global. As such the S&P 500 increasingly follows the global economy more than the U.S. economy.

While the data is still coming in and COVID-19 responses continue to evolve, the U.S. may be seeing a worse economic impact from COVID-19 than certain other countries. Yet the S&P 500 is only partially focused on the U.S., since a significant portion of profits are coming from overseas for many companies.

Looking Forward

The stock market tends to look forward in forecasting the fortunes of companies. For most companies valuations derive from examining 10 to 40 years of future earnings. Hence the market has an ability to look through times of economic weakness to some degree.

For example in the past recession the S&P 500 bottomed in March 2009 but the recession did not officially end until June 2009. This time the market is clearly looking through the current weakness.

The market’s view appears to be a combination of optimism that the government response and the Fed’s actions will reduce the economic hit and sustain asset price valuations and that the necessary actions to contain COVID-19 will be relatively short-lived.

Of course, that’s not to say the the market is necessarily correct in that view, the market is in essence a forecast that could be right or wrong, but it’s fair to say that the market sees an optimistic path through the crisis relative to where we are right now.

Where We Stand

So we shouldn’t necessarily expect the S&P 500 to be too a useful barometer for the U.S. economy. The index is heavily skewed to tech and those companies matter far more for the S&P 500 than they do for the U.S. economy. Single, large tech companies can dwarf entire sectors of the economy, based on how the index is constructed. Secondly, the S&P 500 is now more of an assessment of the global economy than the U.S.

Finally, all stock markets are a long-term forecast of economic activity. Much like forecasting the weather for 2021 and beyond rather than for today. Currently the market has an upbeat view. Now the market is never perfect, it may not be correct in that assessment. For example, valuations are elevated, which is perhaps a reason for caution, but that is where the market is. For all these reasons the S&P 500 may not track the fortunes of the U.S. economy as closely as we might anticipate.



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