Does the Stock Market Care About the Economy?
I thought the two were the same?
We normally look to the relationship between the stock market and the economy to inform our own investment opinions. They are often in sync, and sometimes anticipatory of the other investors’ actions.
The stock market operates as a live sentiment meter for prices, and predicting herd mentality can be incredibly lucrative.
So stock market movement is essentially an investors barometer for the overall economy?
In some moments the market acts erratically in relation to the economy — just look at the initial recovery since March’s Covid-19 Crash. Which raises a question.
Does the Stock Market Care About The Economy?
In short, no; however, the answer is much more nuanced because while current economic figures are relevant, investors care just as much about future economic figures and (more importantly) what other investors believe those future economic figures will be.
To break it down…
The market reflects consumer confidence
Investors in the stock market can be thought of as consumers betting on their favorite companies. In periods of economic growth companies are more profitable and experience higher output. Therefore, they can pay higher dividends, and investors can be confident in their financial stability and success. As such, periods of economic growth, also lead to prosperity in the market.
On the other hand, if there are economic predictors of a recession, the market will tank. Consumers and investors anticipate lower profits and even bankruptcy in a recession, so they buy up less risky assets than stocks to keep their money safe.
The relationship between consumer confidence in the economy, and the market’s performance is relatively simple. This relationship represents the norm for the most part. So what does it look like when the market acts unexpectedly?
Recessions trigger different investor behaviors
One of the weirdest things the market can do, is rise during a recession. This is due to a number of factors, mostly driven once again by the investors perspective.
For example, as mentioned earlier, stock markets are forward looking. When the recession prices are set, investors look to the future and anticipate recovery, leading them to buy up shares in whatever they think will recover its losses. Additionally, interest rates are usually lowered significantly during a recession and lots of people buy them up, leading to government bonds with zero or negative yields. As a result, share prices and yields look much more attractive, leading some back into the market.
The Bottom Line
Any way you look at it, the relationship between the market and the economy can’t be denied. The periods they’re not in sync reflect erratic financial conditions, and are not the norm.
With that said, famous investors have often pined that the market can stay irrational much longer than you can stay solvent. So while an economic downturn may be ongoing or imminent, remember the stock market can still surge.
There is a lot more that goes into the stock market. Read more about it here:
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