There often exists an adverse relationship between Wallstreet (Stock market) and Mainstreet (our Economy) which I have never seen explained by financial media. What is good for the stock market isn’t always good for the economy and vice-versa. Here are 10 reasons, in no particular order -
1) 38% of S&P 500 company revenues are generated outside the U.S. while exports are less than 10% of U.S. GDP. Therefore, the U.S. stock market is much more affected by global strength or weakness than the actual domestic economy.
2) Stock market value fluctuates based on growth or decline in earnings. The volatility in earnings is always greater than the actual change in the economy.
3) Earnings recessions (decline in earnings) can cause the stock market to go down significantly (one of the concerns currently) but may or may not affect the real economy. We endured an earnings recession in 2016 – when the average Russell 3000 stock fell more than 25% - but the economy avoided a recession.
4) Higher unemployment is good for the stock market because it forces the Fed to lower rates to boost the economy. Lower rates are good for stocks - but how can high unemployment be good for any economy?
5) The best stock market returns come when unemployment rate is higher – because the Fed is working hard by keeping rates low to encourage consumers and businesses to spend.
6) Stock market returns are lower when unemployment rate is low. Low unemployment indicates a strong economy, which means the Fed is raising interest rates to control inflation. And given its long history of tipping the economy in a recession – investors are worried sick.
7) Strong wage growth is very good for economic consumption but bad for the stock market. Wage growth pressures business margins, leads to inflation, and forces the fed to raise rates.
8) Higher interest rates are good for savers because savings accounts deliver higher interest payments but bad for stocks because they reduce the discounted future value of cash flows and lead to lower stock prices.
Hope you are starting to connect the dots….
9) Starting in 2009, a tepid recovery (consistent 2% GDP) was ideal for the stock market. Inflation pressure was very low, Fed had to keep interest rates low, and stocks could rise steadily without worries about end of the business cycle. But low growth isn’t ideal for economies because it doesn’t create enough jobs and real wealth for majority of the population.
10) A strong currency could signal a strong economy, but punishes exporters and, in our case, our energy sector. Over the past 10 years, U.S. interest rates are increasingly correlated to oil prices. A stronger dollar (combined with other variables) has reduced energy prices and adversely affected the economy.
The Federal Reserve’s job is to predict the future growth of the economy and walk a tight rope to balance inflation and unemployment. Investors, on the other hand, are walking an even tighter rope in predicting the economy and the actions of the Fed. The interplay in the forward expectations of these two parties changes the perception of the value of businesses that trade on the stock market – which at times has nothing to do with the real economy.
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I am an investor and these are my personal thoughts on investing, behavioral finance, markets, and sports viewed through the prism of a Latticework