You’ve heard it from presidents and pundits, at the PTA meeting and the produce stand: The stock market is up, so the economy is good. Or maybe you’ve heard that, because the stock market is down, the economy is tanking.
While the stock market and the economy often do impact each other, however, they are not the same. Put simply, the stock market is driven by the emotions of investors, while the economy is driven by production and consumption of goods and services.
Certainly, over time, the economy and the market may trend in the same general direction. However, the financial markets tend to react in extreme ways (either positively or negatively) to news events and policy reports that might not have any bearing on a nation’s macroeconomic fundamentals. Thus, what happens in the economy and the stock market might not be entirely related. Knowing this difference can be helpful for understanding your own financial journey.
About 58% of households in the United States owned stocks in 2022, according to the Federal Reserve’s triennial survey of consumer finances. That rate was up from 53% in 2019, and it marked the highest household stock-ownership rate recorded in the Fed survey. Many households own stocks through a retirement account, such as a 401(k). However, direct stock ownership increased to 21% of families in 2022 from 15% in 2019—the largest increase on record since the survey began in 1989.
According to Gallup, 62% of U.S. adults owned stock as of 2024. More Americans in the past few years have invested in individual shares directly.
The Economy vs. the Stock Market
The economy is the sum of all the activities that go into making and spending money within a region or country. The economy can be simply defined as the production and consumption of goods and services.
In the headlines, the economy is often measured and tracked through changes in Gross Domestic Product (GDP), the monetary value of all finished goods and services made within a country during a certain period. GDP is used to estimate the size of the economy.
GDP growth year over year indicates a healthy economy, while slowing growth or an outright decline can be cause for concern. Employment levels, the housing market, consumer confidence, and spending are other ways to measure the strength or weakness of the economy.
The stock market consists of the buying and selling of stocks of publicly traded companies, which comprise just a small subset of the total number of employers in the U.S. economy. Public companies make up less than 1% of all U.S. companies and one-third of non-farm U.S. employment.
Each market has an index: a group of stocks that are selected to represent the overall performance of that market. People will often refer to one of the major stock market indexes, like the Dow Jones Industrial Average or the S&P 500, when they talk about the stock market. Because tracking every single stock is difficult, most people consider these indexes to be representative of the market as a whole. Since the S&P 500 is driven and weighted by a company’s market capitalization, the organizations within it may not represent the largest employers in the U.S. (See our video https://bowenasset.com/videos/
“How Does the Stock Market Work?”)
Looking in Different Directions
It’s important to grasp that the stock market is forward-looking, which means it anticipates conditions, sometimes months ahead of when conditions actually start changing. Stock prices reflect future corporate profits and the conditions that affect them. In other words, the price you are willing to pay for a stock today is based on how well you and other investors expect the company to do in the future.
So, while the stock market is often a leading indicator of how the economy is performing, it is just one indicator; because these two entities belong to entirely different categories, the stock market can underperform even in times when the economy is performing well. The stock market is measured at a specific point in time (for example, at 9:30 a.m., June 4, 2024). The economy is measured during a particular interval of time (for example, from January 1 to March 31, 2024).
In early August 2024, the market experienced a week of heightened volatility for several reasons.
First, July employment came in below expectations and alarmed the market, with investors thinking that the Fed had waited too long to lower interest rates.
Second, the “carry trade” began to unwind. A carry trade is an investment strategy that involves borrowing money in a currency with low interest rates and using it to invest in stock and bonds that provide a higher rate of return.
In this specific case, because Japan has had low interest rates for years, it has been advantageous to borrow yen at a low cost to invest in tech stock in the U.S. as AI euphoria propelled the market forward. But when Bank of Japan raised interest rates on July 31 and presented a hawkish tone for further rate increase, the carry trade began to unwind, causing a downdraft in U.S. stocks. This decline had nothing to do with economics.
Third, the twists and turns of the 2024 presidential election have contributed to market volatility. After President Biden’s troubled debate performance, former President Trump’s selection of Ohio senator JD Vance as vice presidential nominee, and the failed assassination attempt on the former president, the market had more certainty that the Republicans could reclaim the White House. There was a boost in stocks that investors felt would benefit from a Trump/Vance win.
With Biden dropping out of the election and the elevation of Vice President Kamala Harris as the Democratic nominee (and her choice of Minnesota governor Tim Walz as running mate), the race tightened. With a Republican victory less certain (though still possible, of course), investors balked and the so-called “Trump trades” unwound.
Conclusion: Keep Your Perspective
It’s important to approach what happens in the stock market with a strong sense of perspective. Just because the stock market falls 20% does not mean that the world is going to end or that you are about to lose your job or savings.
A more productive way to think about the relationship between the stock market and the economy is to approach it from the perspective of how those making capital allocation decisions might feel about the next 12 months.
If you think about the relationship between the stock market and the economy this way, you’ll be far less likely to get caught up in the “wealth effect” while the market is hot and overextend yourself or to become too pessimistic about the world and your future prospects when the market has trouble.
Instead, you can use your knowledge to adopt a healthy sense of fiscal conservatism that will enable you to invest for the long term like an optimist while preparing for the worst like a pessimist.
Market uncertainty causes increases in volatility. Volatility was the result of the above-mentioned factors in early August. As we go forward through the rest of 2024, Bowen Asset Management continues to expect increases in volatility as we get closer to Election Day, the Fed cutting rates as expected in the fall, economic data releases, geopolitical risk, and a budget battle in Congress in September.
If you like reading our “Bowen Reports Blogs”, Bowen Asset does have a Facebook page: https://www.facebook.com/BowenAsset Please check it out as we frequently make comments on the page about not just finance and
economic events that happen in between our blogs.
As always, if you have any questions about this report or any other questions, please reach out to Bowen Asset at info@bowenasset.com or (610) 793-1001.
Disclaimer
While this article may concern an area of investing or investment strategy in which we supply advice to clients, this document is not intended to constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. Any statements regarding market or other financial information is obtained from sources which we and/or our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. All expressions of opinion reflect the judgement of the author on the date of publication and are subject to change.
Past performance should not be taken as an indicator or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. As with any investment strategy or portion thereof, there is potential for profit as well as the possibility of loss. The price, value of and income from investments mentioned in this report (if any) can fall as well as rise. To the extent that any financial projections are contained herein, such projections are dependent on the occurrence of future events, which cannot be predicted or assumed; therefore, the actual results achieved during the projection period, if applicable, may vary materially from the projections.