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Why Horrific Unemployment Numbers Made The Stock Market Rise

(CBSNewYork) -- Last Friday, the Bureau of Labor Statistics released some disturbing unemployment numbers. The official unemployment rate jumped from 4.4 percent in March to 14.7 percent in April. The final rate and the month-over-month increase both marked records for the series, which uses data dating back to January of 1948. The actual unemployment rate exceeds 20 percent.

That three-fold increase in the official unemployment rate was met with a strong day on Wall Street. The Dow Jones climbed 445 points or 1.91 percent to 24,331 on Friday; the S&P 500 rose 1.69 percent. The Dow began the year north of 28,000 and plunged below 19,000 in late March as coronavirus began to shut down the nation's economy. It has since gained back more than half those losses.

All that optimism may seem counter-intuitive. How could such bleak unemployment news spur a rally on Wall Street? There is some logic behind the reaction, even if one disagrees with the conclusion. To understand the thinking, let's take a couple steps back.

What is a stock? In its simplest form, a stock is a tiny piece of a company. From another view, "the definition of a share of stock is the net present value of a perceived future stream of income," according to Giacomo Santangelo, economics professor at Fordham University and the Stillman School of Business at Seton Hall University. "So if a stock is selling for $100 right now, that means that the people within the [stock] market -- people buying it and people selling it -- have a belief that over the time horizon of their investment, I'm going to receive $100 worth of value from it."

What is the stock market? The stock market, at the most basic level, is the market for stocks. It's where potential buyers and sellers of stock buy and sell shares of stock. "When we're talking about the market, people like to talk about the Dow [Jones], people like to talk about the Standard & Poors," says Santangelo. "You're looking at an average stock performance of 30 or 500 or however many [stocks], depending on which stock index you're looking at."

The Dow Jones Industrial Average is one of those stock market indexes. It tracks the stocks of a select group of 30 big publicly owned companies, including Apple, Disney, Goldman Sachs, Microsoft, Wal-Mart and others. The S&P 500 is a broader stock market index that spans 11 sectors of the economy and follows the stock performance of about 500 large-cap, U.S.-based companies. Those include Alphabet (Google's parent company), Amazon, Exxon, Facebook, United Health and many others. There is plenty of crossover between these two indices, but each provides a snapshot of the domestic stock market and economy. The important thing to note is that the view is forward-looking.

Investors were eyeing the future last Friday, when the market reacted to horrific unemployment numbers with significant gains. Many in the market believe that unemployment has peaked and the economy has bottomed out. Further, much of the unemployment was reported as temporary layoffs, meaning those workers will eventually return to their jobs. Current low interest rates will facilitate growth. And the government, through stimulus payments and the Federal Reserve's quick action, seems prepared to keep spending as needed.

All these factors create an environment conducive to recovery. Growth and a sort of return to our pre-coronavirus days are perceived to be in our collective future. Tech stocks, which have thrived with people stuck at home during the pandemic, continued to do well last week. Airline and hotel stocks, which have suffered, received a boost as the reopening of parts of the economy came into focus.

"The stock market was responding not to reality, but to perception," Santangelo notes."The stock market is just as much about psychology as it is finance. If you convince people that stores are getting ready to reopen and that this Friday New York is going to start lifting restrictions and things are going to start working well..." then the gains will follow.

In the scene Santangelo lays out, "the weather is nice. We're going to start seeing improvements. Parks are starting to open. We're having opportunities to start going back to restaurants. Literally that perception will drive the market to have positive returns, because the market is about perception."

But perception isn't reality. And a future economy that faces a largely uncontrolled virus could play out in a lot of ways. Here's a quick look at some of the mitigating factors.

The unemployment rate, which the market reacted to last Friday, looks backward to April. The job losses have continued, however; almost 3 million people filed new unemployment claims last week. Most of the losses through April have been classified as temporary and come in blue-collar jobs, which people can't do at home. If the economy doesn't rebound fast enough, some of those losses will become permanent and spread to white-collar jobs.

Even with a strong recovery, many people won't be returning to their old jobs. Hard-hit industries like restaurants and airlines, for example, won't need the same number of employees to serve half as many customers in a socially distanced world. Some portion of the approximately 18.1 million temporary layoffs will become permanent as companies adjust to their new reality.

Unemployment won't return to pre-pandemic levels anytime soon. Consumers without jobs spend less money. And two-thirds of the economy is driven by consumer spending. The stock market's optimistic view of the future also assumes that consumers -- and workers -- will even want to venture out and risk contracting COVID-19 without adequate testing and contact tracing, never mind a vaccine.

These and other factors make predicting the country's economic future next to impossible. Viewing the situation through the lens of big business, as the stock market does, obscures things even further. Small and mid-size companies, many of which are struggling, aren't represented in the stock market. And small business accounts for upwards of half of the country's economic activity.

The stock market didn't react to economic reality last Friday, when April's unemployment numbers were announced. It reacted to a narrow perception of economic reality.

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