Thursday, December 11, 2008

The Stock Market and the Economy Aren’t the Same Thing

It may seem obvious when you think about it, but the stock market and the economy aren’t exactly the same thing. Some commentators seem to confuse the two. There is no doubt that they are related to each other, but they don’t always move in the same direction.

The stock market reflects the going price for businesses that are at least partially owned by the public. The economy includes these businesses plus privately-owned businesses, bond markets, currency markets, governments, jobs, etc.

Stock prices are a consensus view of the expected future profitability of public businesses. This makes the stock market forward-looking. Sometimes the crystal ball is cloudy and stock market participants get it wrong, but stock price movements tend to precede changes in the economy.

We have seen this lately in media stories. As stock prices dropped, we heard story after story of gloom and doom about the stock market. This has largely given way now to gloom and doom about the economy. Apparently we’re all going to lose our jobs and have to start flipping burgers for a meagre living. Unfortunately, this really will happen to some of us.

If past patterns repeat, we can expect stock prices to rise before we pull out of recession. But don’t take this as a prediction from me. Short-term stock market movements have a way of surprising us.

1 comment:

  1. Equities markets are a leading economic indicator, that is why they are so often tied together in the media. This is also why stock markets recover in advance of the economy.