Warren Buffet had a mentor named Benjamin Graham, who said the stock market is “a voting machine in the short run and a weighing machine in the long run.” In other words, it is nothing more than a popularity contest in the short run, with the prettiest stocks winning. However, in the long run, the stock market carefully evaluates the balance sheets, income statements, marketing plans, and strategic plans of each individual company. That is one reason that the current stock market does not reflect our current economic condition. The stock market is forward-looking. Indeed, the level of the stock market is part of the Index of Leading Economic Indicators (LEI) – notice the word LEADING. As a rule of thumb, we say the stock market reflects the best thinking about conditions in six to nine months, maybe longer. Today, the best minds on Wall Street obviously don’t think the world is ending.
Also, there is a tendency to see the abundance of economic, financial and political problems that we face as something new. Back in the late 1950’s, the stock market continued to rise, even as the Cold War heated up. Bulls pointed out that investors were facing a “wall of worry” – about war and recession. Sometimes, that wall is high and sometimes it is low, but there is always plenty to worry about. Wall Street has always worked under conditions of uncertainty. They’re used to it. They have never worked under conditions of certitude and never will.
Another reason for the Great Disconnect is the quick arrival of the Calvary, the 3rd Army, and the 101st Airborne. In other words, both monetary rescue and fiscal rescue came very quickly. More than anything else, this has buoyed Wall Street. Frankly, what took the Fed 18 months to do in 2008-10 only took 48 hours this time. In fact, the Fed is doing more this time! Even the elected children in Congress quickly passed legislation to increase our annual deficit by $2.2 TRILLION over the next 12-16 months, and more fiscal rescue is expected after that. Wall Street knows what Washington is sending, but neither the economy nor the virus know it yet.
However, a disturbing implication is that this disconnect between the stock market and the economy is the belief that our current collapse will destroy smaller companies, leaving only the larger companies. (The PPP program proves the point.) Just like the Great Recession left big companies stronger, the Great Collapse will do the same. That’s a shame . . .