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Why the S&P 500 Index Hit a Record High During an Economic Low

Score Priority Team
Posted by Score Priority Team on Sep 3, 2020 12:24:12 PM

The S&P 500 hit record highs in August 2020 despite the economic downturn.

Pop quiz: what caused the Great Depression in 1929?

Answering with the stock market crash can be tempting, but the correct answer is more complex than that. Economic historians usually cite rising bank loans and speculation, higher interest rates, agricultural complications, and public panic as factors, but most people just remember Black Tuesday as an all-encompassing, shorthand explanation.

Many consider stock market performance as a representation of economic performance. And while stock market activity can be a bellwether of an economic movement or a symptom of a greater trend, there isn’t a direct relationship between the two.

For the past half a year, the markets have been rising and dropping like a rowboat in a storm. On March 16, the Standard & Poor (S&P) 500 was down by 8.1 percent at the opening bell, invoking a circuit breaker halt for 15 minutes. It fell by about 12 percent by the end of the day.

Five months later, the S&P 500 stock index recovered its March losses and then some. On August 18, it rose to 3,389.78, finishing at the highest closing level on record. Since then, the S&P 500 continued to break its own record throughout August, culminating in its best August performance since 1986. These new all-time highs technically signaled the end of this year’s bear market.

Yet many people are scratching their heads, wondering how there can be an end to a bear market when the economy is still struggling to recover. To answer that, let’s look at the role of the S&P 500 index and the unique circumstances of this recession.

STANDARD & POOR

In 1941, Standard Statistics Company (which initially rated mortgage bonds) and Poor’s Publishing (which originally guided investors in the railroad industry) merged to form Standard & Poor’s. 16 years later, they created the S&P 500 Stock Composite Index.

The S&P 500 is a stock market index that measures the stock performance of 500 large-cap U.S. equities, covering approximately 80 percent of available market capitalization. Since it represents the largest stocks in the U.S., analysts often use this index as an indicator of overall market performance.

With the stocks weighted by market capitalization, the top 10 stocks in the index make up approximately a quarter of the index's market value. Therefore, the performance of the top 10 stocks listed in the index can dramatically affect market movement; those stocks (as of this article’s publication) are Apple Inc. (AAPL), Microsoft Corp., (MSFT), Amazon.com Inc. (AMZN), Facebook Inc. Class A (FB), Alphabet Inc. Class A (GOOGL), Alphabet Inc. Class A (GOOG), Berkshire Hathaway Inc. Class B (BRK.B), Johnson & Johnson (JNJ), Procter & Gamble Company (PG), and Visa Inc. Class A (V).

Although the index seems similar to the Dow Jones Industrial Average, the Dow is weighted based on the share price of each company, not the market cap, which means companies with higher share prices have a greater weight.


STOCK MARKET RESURGENCE, ECONOMIC REHABILITATION

With many industries either closed or at limited capacity for the past few months, the economy has seen better days. In the U.S., real gross domestic product decreased at an annual rate of
32.9 percent in the second quarter of 2020. Unemployment in the U.S. hit 14.7 percent in April, and while that number has been steadily declining, the unemployment rate is still in double digits.

Although many use the stock market as an indicator of economic health, the factors that affect the S&P 500 index are not necessarily the same considerations for the economy. And instead of a widespread recession across all industries, the unprecedented circumstances of the COVID-19 pandemic affected some industries while others flourished.

Economists use the U.S. gross domestic product (GDP) as a measure of goods and services produced by the economy. The services sector impacts a significant portion of the GDP, and with many of those businesses hindered by mandatory lockdown measures, the GDP has suffered a substantial blow.

Meanwhile, other industries had an exclusive advantage during the pandemic. Consumer discretionary stocks, which include Amazon, prospered during 2020, as well as the information technology sector. In fact, information technology had gained more than 63 percent in mid-August since March.

Information technology comprises more than a quarter of the S&P 500, meaning their performance has more influence on the index’s performance than most other sectors. For example, energy only makes up about three percent of the S&P 500. So, if the price of oil crashes, what happens to the tech sector matters more than eight times more to the S&P 500 than the energy sector.

Another reason why the S&P 500 has been hitting record highs may simply be because of optimism. Trillions of dollars in stimulus aid from the Federal Reserve and Congress have been a lifeline for the economy. Moreover, improved consumer spending, corporate profits that are better than expected, and a rebound in the housing market may have contributed to investor confidence.

This recovery through the third quarter is not the first time the stock market recovered faster than other economic elements during a recession. While investors may rejoice, economic health relies on more than the performance of one index.

The markets can be an exciting challenge; that's why Score Priority has the tools to help you know the score. Please feel free to visit our website to learn more.

 

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Topics: stockmarketanalysis, sp500, stockmarket