TKer: One of the most misunderstood moments in stock market cycles

A version of this post first appeared on TKer.co

The stock market is a discounting mechanism, which means its price reflects expectations for the future, and its price fluctuations reflect the market’s attempt to factor in changes to those expectations.

Believe it or not, in a given moment, the stock market does not care too much about the present state of things. That’s because expectations for the present will have been priced into the market days, weeks, and months in the past.

That is to say, the stock market reacts to news to the degree the new information 1) is not in line with what the market expected for the present, and 2) changes what the market expects for the future.

There are some more factors that drive stock prices over time. But in the context of digesting major news headlines, these are the two relationships to watch.

Because the stock market is so heavily dependent on expectations for the future, we inevitably get moments when stock market behavior appears to conflict with information about the present. Specifically, we sometimes get stock prices falling amid good news and rising amid bad news.

These are some of the most misunderstood moments in stock market cycles.

One of the more dumbfounding instances of this counterintuitive dynamic came during the spring of 2020 when the economy was reeling from the COVID-19 pandemic lockdowns.

After a sharp 35% drop, the S&P 500 bottomed and inflected upward on March 23 that year.

But we continued to get disastrous economic reports for weeks as the stock market rallied.

This resulted in one of the defining screengrabs of the pandemic. It was from the April 9 episode of "Mad Money with Jim Cramer." Cramer’s show highlighted how the stock market had its best week in decades while the chyron reported the cumulative three-week tally of unemployment insurance claims ballooned to 16 million.

People were confused.

Yes, the economy was in bad shape in April. But expectations were already extremely low, which meant the bar for developments that could cause stocks to go higher was also very low.

In retrospect, it seems the stock market got it right.

It wasn’t until June that we learned job creation resumed in May. And it wasn’t until July 2021 that we learned that the recession had ended in April 2020.

The stock market, for its part, recovered all of its pandemic losses and reached new record highs in August 2020. (So, if you had dumped stocks as the news was getting bad and you had waited for good news to get back in, then you might’ve actually missed out on considerable gains you could’ve earned by just holding through the crisis.)