May 05, 2020
Daniel W. Drezner used his Washington Post column to contribute to the confusion around the stock market and the economy. He picks up from prior pieces by Paul Krugman and Desmond Lachman as to whether the recent run-up in the economy means investors are expecting a strong recovery.
(Drezner unfortunately refers to the question of a V-shaped recovery. The Congressional Budget Office projects that the economy will shrink at a 39.6 percent annual rate in this quarter, and then grow at 23.5 percent and 10.5 percent annual rates in the third and fourth quarters, respectively. It would be hard not to view the projected 3rd and 4th quarter growth rates as “V-shaped,” but they would still leave the economy more than five percent smaller than it was in the fourth quarter of 2019. The question is not really the shape, as opposed to the size of the right side of the “V.”)
Anyhow, in his subsequent discussion Drezner focuses on projections for the state of the economy, ignoring what the stock market is supposed to price — the value of future after-tax profits. If a change in policy has zero positive impact on economic growth, like a cut in corporate income taxes or a strong anti-union measure, but is expected to increase after-tax profits, we would expect it to lead to a rise in stock prices.
The willingness of Congress and the president to give a massive bailout that looks very favorable to corporate interests likely was viewed by investors as a signal that the politicians in Washington were determined to limit the damage that corporations faced as a result of the pandemic. There is little reason to believe that they were looking at how well the economy would do. (Krugman’s line, that they expect a very weak economy and therefore very low interest rates, is an exception to this view.)
Anyhow, no reasonable person would make a serious economic projection based on the Yankees prospects for winning the World Series, nor should they make economic projections based on fluctuations in the stock market.