The Market and the Economy are Two Different Things

The Market and the Economy are Two Different Things

May 10, 2022

In times like these, investors tend to look at news in the economy and translate that to the stock market.  It makes sense.  If the economy is suffering, then companies will struggle to make money, resulting in loss of value.  If it worked that way my job would be easy and the stock market would be an extremely predictable animal.

However, it’s not.  Investors in the market care more about the future than the present or the past.  Stocks are priced based upon the future ability of companies to make money, not upon the value that they returned last year.  Thus, the equities market is really just a giant educated guess.

Once you understand that, the volatility of the market becomes much easier to understand.  There are THOUSANDS of metrics out there that attempt to predict growth.  Some of those metrics are economic, while others are company or industry specific.  Investors pick and choose from all that data to try to make their own determination about the growth or lack thereof from corporations.  And there is always information that points both up and down.  Buyers and sellers are in a constant argument over who is right. 

Let’s not get too far from the point here, though.  The market and the economy, while they are related, are not the same.  If you look at the table that our friends at First Trust put together using Bloomberg data, you’ll see some grey shaded areas.  Those are economic recessions.  And if you look at the stock market performance, you’ll notice two glaring trends.  The market almost always moves backwards BEFORE a recession actually strikes, and almost always move forward BEFORE the recession ends. 

Remember that investors are always trying to guess where the economy is headed, not where it currently is.  As a whole, they do an extremely good job of that.  Signs of economic slowdown start to become apparent, investors become nervous and could begin selling stocks, then the economy enters recession.  Later on, economic data starts to look a little better, investors get excited, and they buy stocks before the recession is technically over.   

On a side note, this chart is extremely useful as a tool.  We will revisit other lessons from it very soon.

As an investor, you need to understand that when the news about our economy is at its worst, the market has, in all likelihood, already priced all that in.  Don’t confuse the worst of the economic news with the lows in the stock market.  History tells us that they don’t go hand in hand. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  All performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and may not be invested into directly.