Investors are often bombarded with economic data, company news, market information, and news headlines. Not only can this be overwhelming, but it can lead to confusion.
The best analogy I’ve heard on this subject comes from CNBC’s Josh Brown, who likened the economy to a person walking their dog (the stock market). The person walks in a line. The stride is straight forward, with subtle deviations-like an economic trend. Like the stock market, the dog moves off here and there, can be impulsive, and makes noise barking. While both the person and dog are walking in the same general direction, their paths are different (CNBC, 2019).
Stock markets are generally forward-looking, focusing on corporate sales and profits. Economic data is a better reflection of Main Street conditions such as unemployment, wages, sentiment, and inflation.
So does one influence the other? It depends. We’ve seen the dot com bubble as a prelude to a meaningful recession, yet we’ve also seen years of poor economic growth be accompanied by high market returns. In fact, 2019 was an example of that with the S&P 500 up over 30% despite slowing GDP growth.
To be sure, the two are intertwined to a degree. However, I would strongly caution anyone making market predictions based on an economic forecast, as the latter is extremely hard to predict. It is said that if you put 8 economists in a room, you’ll get 14 opinions. Further, there are so many factors that influence the stock markets beyond company earnings and expectations. Fear, greed, trade, and other geopolitical issues can cause irrational behavior.
The bottom line is that short term predictions are often wrong. That’s why we favor a management style focused on long term outcomes and built to withstand the short-term noise.
CNBC. (2019, April 5).The Difference Between the Stock Market and the Economy. Retrieved from: https://www.youtube.com/watch?v=59im9CtR9YI