Schwab Market Perspective: Disconnection

The U.S. stock market has rallied to new highs, but some of the recent “winners” were companies that aren’t profitable and/or had been widely bet-against (“shorted”) by hedge funds. Hope is high that economic growth will accelerate as more people are vaccinated against COVID-19, but so far economic data has been lackluster. Meanwhile, bond investors are expecting inflation despite signs that the economic recovery’s momentum may be stalling. Why does everything seem so disconnected?

U.S. stocks and economy: Frothy sentiment, but solid participation

The pace of COVID-19 vaccinations has been improving around the world as manufacturing and logistical issues are worked out. The road to herd immunity is long, although the total number of administered doses is now outpacing total infections and the trajectory of new cases, hospitalizations, and deaths is improving.

However, this success hasn’t yet been reflected in broader economic data. Fourth-quarter gross domestic product (GDP) growth was weaker than expected, and the U.S. economy added a tepid 49,000 jobs in January—much less than the consensus estimate of 105,000—while December’s payroll shrinkage was revised lower, to -227,000 from -140,000. The unemployment rate ticked down to 6.3%, but for the “wrong” reason: Labor force participation fell, as fewer Americans tried to find jobs.

Long-term unemployment has shown no improvement. As seen in the chart below, nearly 40% of unemployed individuals have been without a job for at least 27 weeks. Aside from the three years after the 2007-2009 Great Recession, this is the highest percentage on record. Permanent job losses also ticked up in January, underscoring that scarring effects on the unemployed are becoming widespread.

Chronic long-term unemployment remains an issue

Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics (BLS), as of 1/31/2021.

Nevertheless, the U.S. stock market has continued to rally. In one of the more bizarre trading events in recent memory, a tidal wave of retail traders bid up prices in a small subset of the market: unprofitable technology companies, stocks most-shorted by hedge funds, and those most-favored by retail traders. The most prominent of these was GameStop, a brick-and-mortar video-game retailer, but the frenzy also targeted movie-theater chain AMC Entertainment, mobile-device maker BlackBerry, and home goods superstore Bed Bath & Beyond. The hedge-fund community had heavily shorted many of these stocks—that is, borrowing and selling shares at the current price, hoping to buy them back at a lower price to return to the lender. When retail traders began piling into the stocks, rising prices caught the hedge funds in a “short squeeze,” leading to even more buying.