When it comes to the relationship between economic data and stock market behavior, “better or worse tends to matter more than good or bad.”
But in today’s uniquely-traumatic economic crisis, it’s important to consider both rate of change and level.
It’s likely going to take a significant span of time to get to pre-pandemic levels; with the recovery likely to be more “rolling Ws” and less an ongoing “V.”
For decades, when discussing the relationship between economic data and stock market behavior, I’ve shared the perspective that “better or worse tends to matter more than good or bad.” In other words, trends—and in particular, inflection points—in the data tends to have a larger impact on stock market action than levels. It’s human nature to think about the economy and its component drivers with a good vs. bad or strong vs. weak perspective. But as has clearly been seen in the past couple of months, the turn in economic data—even if the levels of that data—can be a powerful elixir for the stock market.
A V-shaped economic recovery narrative has taken root; courtesy of both the move off the bottom in a wide variety of economic data points; but also the epic rally in stocks off the S&P 500’s March 23 trough. There is no quibbling with the V-shape surge off the economic bottom (which for now appears to have been April or May depending on the metric); but in these unique times, level should be considered as well. The “law” of small numbers is such that, when you compress economic activity to near-nil courtesy of a full-stop economic shutdown by government mandate, the percentage gains off those lows will look exceptionally strong. But be careful with regard to extrapolating these early percentage gains.
Remember this simple math—a drop of 50% in the price of anything requires a 100% gain to get back to even. Even a 25% drop requires more than a 33% gain to get back to even. I think you get the point. Below are charts showing monthly or weekly change for a variety of well-watched economic data points; as well as their level or yearly change versions. As you will see, there is a huge difference in what is likely perceived if you limit your analysis to the shorter-term/rate-of-change perspectives.