Economy vs. Stock Market
Many clients have asked for our opinion about the stock market and, at the same time, the economy. Most people believe they are one and the same. They aren’t. The way to think about the relationship between the two is that the stock market is a fortune teller for what will happen to the economy in the future. This is why the stock market is one of the major leading indicators of what will happen in the economy six months or so down the road. We have recent history to show us how this works.
Last September, the nation’s unemployment rate was 6.2% and although the economy was not great, it was ok. We all know what happened over the course of the next month as stock prices collapsed. The size of the pain on Wall Street was not immediately felt in the general economy because the unemployment rate rose only to 6.6%. This month’s unemployment rate is 9.5% and wasn’t reached until seven months after the market’s major downturn!! Expectations are that the unemployment rate will rise to above 10% over the next few months. This is not surprising and it should be expected. The stock market foretold us of the bad economic times to come back in October. The fortune teller was right.
What is the market telling us now? The market has rebounded nicely from its market lows of March and, we believe, is forecasting a better economic environment six months or so from now. We won’t know if the fortune teller is right until sometime early next year. Nonetheless, there are some fundamental reasons why people have been buying stocks recently.
Some people are asking, “Why is the market up when things look so bad in the economy?” Individuals buy stocks based on future expectations of a company, not past results. Company earnings have taken it on the chin the past two quarters – that is what the stock market fall in October of last year told us would happen. Companies have cut costs by reducing staff, inventories and expenses among other things. Companies are very lean at the moment. If companies get just a small bump up in sales, their earnings will look very good. Why? Because, after a recession companies do not hire people back right away – that is why unemployment will continue to rise, they don’t add significantly to inventories and they don’t increase expenses. They want to make sure the recovery is real and sustainable. So as sales increase, the proceeds go right to the bottom line in higher earnings. The stock market is up based on expectations of those future higher earnings.
Thank you for your continued trust and confidence,