If you’ve been following financial news over the last six months, you may have noticed the contrast between the strong recovery in the stock market and the lagging recovery in the overall U.S. economy. This surprising divergence between “Wall Street” and “Main Street” has left many wondering how the situation arose and what it means for the stock market over the next several months.

When did the divergence between Wall Street and Main Street begin?

From late February through March, the S&P 500 dropped nearly 35 percent as the COVID-19 pandemic slowed the U.S. economy. As the virus spread, the Federal Reserve acted quickly to lower the Federal Funds Rate within a few weeks from more than 1.25 percent to 0-0.25 percent. In addition, Congress quickly passed a stimulus bill designed to support small businesses and consumers. Soon after, record numbers of unemployment claims were reported and it became apparent the economic contraction would break long-standing records.

Economic data, which reflects the health of “Main Street,” has improved modestly in recent months. However, unemployment remains near 8.5 percent and gross domestic product (GDP) is reported to have contracted nearly 32 percent in the second quarter.

In sharp contrast, the S&P 500 Index (one measure of “Wall Street” health) began rising in early April and had fully recovered from the decline by mid-August. As of September 2, the Index was up more than 12 percent for the year and closed at an all-time high.

Why did the divergence between Wall Street and Main Street occur?

The strong rebound in the equity market was fueled by several factors. For example, the Federal Reserve pledged to keep the Fed Funds Rate low well into the future to support the economy as it reopens. This action tends to keep interest rates low, making stocks more attractive compared to bonds and driving stock prices higher. In addition, economic stimulus programs launched by Congress have helped sustain consumer spending even though unemployment remains high. But these drivers are only part of the story.

The equity market is often called a “leading indicator,” meaning it tends to appreciate months in advance of expected economic improvement. In contrast, economic data for categories such as employment, housing and GDP are frequently called “lagging indicators” because they are reported weeks or months after the period to which they pertain. This difference in perspective – forward versus backward looking – means that Wall Street and Main Street sentiment are not typically in sync.

Another factor driving the divergence is the rapid change in consumer spending. As workers quickly shifted from working at the office to working from home, sales of a wide variety of technology products and services increased dramatically. For example, Zoom Video Communications, a global provider of virtual meeting services, reported a 355 percent increase in revenue in the second quarter (year-over-year) due to growth in the number of subscribers as well as the expansion of services across its existing customer base.

wall street vs main street

In addition, there has been a steep increase in the sale of grocery and other consumable products, driven by consumers spending more time at home. This trend has greatly benefited “big-box” retailers such as Target Corporation, which reported second quarter comparable sales growth of more than 24 percent, the strongest quarterly growth the company has ever reported.

Certain stock market sectors have benefitted more than others from the shift in consumer spending. As of early September, the share price of the stocks in the Information Technology sector of the S&P 500 Index have appreciated nearly 30 percent on average so far this year. The Consumer Discretionary stocks in the Index posted a return of more than 18 percent on average over the same period. The Healthcare stocks in the Index are up nearly 5 percent on average for the year. Most other sectors of the Index still have negative returns for the year.

Although the pandemic has benefitted only a few of the eleven economic sectors, the benefit has been enough to propel the stock market higher well ahead of meaningful improvement in the broader economy.

What does the divergence mean for the stock market?

The disconnect between “Main Street” and “Wall Street” has left many investors wondering if the stock market has gone too far too fast and is now set up for another decline. The direction of the market from here is dependent on how the reopening of the economy proceeds, whether Congress continues economic programs to support consumer spending, and if the development and distribution of a vaccine occurs soon, as expected. All three are likely to proceed in fits and starts, leading to market volatility. Nevertheless, the economy and market will converge over time, as they have done through many economic cycles in the past.

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The information within this article is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this article are based on the views of BTC Capital Management and on information available at the time this article was prepared. This commentary contains no investment recommendations and you should not interpret the statements in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.