The Henderson Group | The Economy and The Stock Market
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The Economy and The Stock Market

The Economy and The Stock Market

Stock markets jump around. If you pay much attention to that you can easily lose sight of the more important story which in 2018 has become even easier to ignore. Is the stock market telling us something about the economy?

As of the end of November, the major U.S. stock indices have erased all their gain for 2018… as media types will breathlessly tell you over and over and over. The world is truly ending! Financial Armageddon is upon us!

Within the torrent of these headlines, it becomes increasingly difficult to separate the “noise” of the headlines from the “signal” of actual economic activities.

We have had an extraordinary run up in the US stock markets since the last recession its attendant market drop. For most folks, the recent ride has been pretty smooth. We tend to remember what has happened to us most recently and recently, at least prior to 2018, we have not had a downturn of any duration in stock prices in a decade.

Over the long term, the US stock market has averaged about 10% per year – a solid return by most anybody’s measure. 10% might be the average stock price return but the returns in any given year will probably be far from average.

Josh Brown of Ritholz Wealth Management has a very descriptive analogy. Imagine someone is walking a very active dog through the park on a leash. The dog’s owner is taking measured steps, walking in a straight line, upright and at a moderate pace. Nothing terribly exciting. Then look down at the dog, The dog is going crazy, It is barking loudly at other dogs, sniffing itself, digging up clumps of mud, leaping at birds and butterflies it will never catch. The dog is the stock market. The dog’s owner is the economy. If you are only watching the dog, you are not seeing the economy. You are watching the greed and fear of millions of people not a representation of how the economy is doing.

Is there a connection between the stock market and the economy? Absolutely, the stock market can reflect people’s perceptions of the economy. Over time the dog and the dog walker will generally move in the same direction. It is important to remember that they are not one and the same, particularly in the short term.

The US economy remains solid. Unemployment is low. Wage growth is continuing to move up. Both manufacturing and service sector purchasing numbers have grown. Consumer confidence is high and small business owners are feeling positive. One historically useful set of numbers on economic health is the Leading Economic Indicators or LEI numbers published by the Conference Board. I won’t bore you with the forensic evaluation, but simply leave with you that the numbers remain positive.

Does all that mean we have seen the end of the market downturn and should anticipate price recovery? One thing I can say with absolute confidence is that no one can accurately predict future human behavior. While in any human endeavor logic does not always prevail, if the U.S. economy remains solid and if investors can begin to distinguish the signals from the noise, resurgence in stock prices is a logical sequitur.