COVID-19 is Controlling the Economy

From crashing stock markets to the Federal Reserve responses, COVID-19 has seemed to control the US economy this past year.

The stock market is now intertwined with COVID – when cases spike, the market drops, and vice versa. What are the implications of this effect on the economy overall? Is it good or bad that the market is so volatile, especially when one sentence from Trump can send stocks soaring? How will the market play out if coronavirus cases continue to rise versus when a vaccine hits the market? Insights@Questrom spoke to Andrea Vedolin, Dean’s Research Scholar and Associate Professor of Finance at Questrom, about the ways in which the economy and COVID-19 affect each other.

THE STOCK MARKET SEEMS TO BE INCREASINGLY INTERTWINED WITH COVID-19; THE MARKET TENDS TO DROP WHEN CASES SPIKE AND THEN RESOLVE ITSELF WHEN GOOD NEWS OF A VACCINE BREAKS. WHAT ARE THE IMPLICATIONS OF THIS MARKET VOLATILITY FOR THE U.S. ECONOMY?

Vedolin: Currently, there is quite a bit of a disconnect between the number of cases and the stock market (at least in the US). While cases have been rising significantly over the past couple of weeks, the stock market has been going up due to the vaccine news. The volatility on stock markets is quite low, especially when compared to the numbers we have seen in Spring. Another disconnect is between the stock market and the economy itself. The stock market had a very fast recovery after the big crash in March. Since then, the S&P500 gained almost 60% and compared to last year, the S&P500 is actually up around 16%. For the real economy, however, there is still a lot of uncertainty on the horizon. While unemployment numbers have come down significantly, it is still not clear how fast the economy will recover even once a vaccine is widely available.

To give you an example of how difficult it is to revive the economy, take the Payment Protection Program (PPP), which provides loans to companies to pay labor cost, rent, etc. It was rolled out very quickly, however, recent research shows that the program increased employment at businesses eligible for PPP by only 2% compared to businesses not eligible for PPP and did so at a cost of over $300,000 per job saved. The issue is that these programs benefited industries, which were not significantly harmed by the pandemic. How fast the economy is going to recover in Q1 and Q2 of 2021 is therefore going to depend a lot on what Congress decides and how effective these programs are going to be in the end. These programs must target not just firms but also households and local governments.

HOW MIGHT THE FEDERAL RESERVE RESPOND TO THE STOCK MARKET IN THE COMING MONTHS?

Vedolin: The Fed has been incredibly quick at responding to the outbreak of the pandemic. By mid-April, they had already rolled out and implemented a very broad array of actions which were targeted at four different areas: 1) financial markets functioning, 2) households, 3) firms, and 4) local and state governments. While many of the actions resemble those undertaken during the Global Financial Crisis in 2008-2009, some new measures target firms and households directly. However, the Fed’s actions alone may not be sufficient; it needs action by the Treasury and Congress, such as a new round of unemployment support, help for state and local governments, etc. In November, Treasury Secretary Mnuchin announced they would end several emergency Fed loan programs. as he is quite optimistic about economic fundamentals. According to Mr. Mnuchin, the biggest threat to the economy are local and state lockdowns, while Fed. Chair Powell is painting a significantly bleaker picture for the economy as many still remain out of work. In the end, it will all come down to how Congress, the Treasury, and the Federal Reserve will cooperate and whether they can agree on the right measures.

WHAT DO YOU THINK THE STOCK MARKET WILL LOOK LIKE IN THE LONG TERM AFTER A VACCINE COMES OUT?

Vedolin: After the economy’s rebound, the stock market in China and firms’ corporate profits have been doing extremely well. I assume the US stock market will continue to do well especially once the vaccine is out. But who knows these days what long-term even means.