Many recent articles cite the never-ending stock rally and low jobless rate as indicators of economic health. But can stock markets really be used as a reliable indicator of, well… anything?
Once upon a time, the stock market may have been thoroughly intertwined with economic conditions. These days, however, stock prices are as likely to be influenced by random tweets, rumors, or public sentiment as by actual facts and figures. The accessibility of trading has removed most of the significance from movement in the stock market. Trades are being executed by algorithms that cull information from Twitter, by John Smith on the subway who just heard that Apple’s new phone has hologram technology, and by computer programs designed to watch for big movements in the market and just follow along (an actual investment product pitched to me by a salesman).
None of these things has anything to do with the overall health of the economy. Underlying data in the stock market, such as earnings, balance sheets, and cash flows, could still be useful in assessing the status of companies, and thus aspects of the economy, but stock prices alone are virtually useless. It’s impossible to know how many trades are based off of fundamentals as opposed to whims or fancies. Examples like United’s stock price dropping over 4% after their videotaped PR debacle, or Toyota losing nearly 1% after a Trump tweet in January, show us just how un-fundamental stock trading can be. Often these losses are quickly reversed, which is only further indication that much of the activity in the stock market is based on price movements and not underlying data.
No, a healthy stock market does not equal a healthy economy. Some other, more reliable, factors do indicate continued economic growth. The unemployment rate is low, housing prices are up, and consumer confidence is strong. There is a flip side, though – inflation is below target levels and wage growth remains stagnant. And the bond market – in nearly direct contrast to the stock market – is indicating unease with future economic growth. Despite the Fed’s three rate hikes, the yield curve has only flattened, bringing long term bond yields closer to those of short term yields.
But, you may ask, why should we trust the bond market as an indicator if we don’t trust the stock market? Tune in next time for more on that.
This information is not intended to be used as the only basis for investment decisions, nor should it be construed as advice designed to meet your particular needs. You are advised to seek the advice of your financial adviser, legal or tax professional, prior to making any investment decision based on any specific information contained herein.
