Typically, the stock market and a country’s economic performance are aligned. A positive economic outlook, job growth, and high consumer spending are indicators that can lead to a bull market — a period of overall positive growth in the stock market. On the flipside, political instability, interest rates, inflation, rising unemployment levels (which affects consumer spending) can all cause the markets to turn red. The more an economy stagnates, the stock market enters a bear market.
Economic growth can be measured in several ways, but one of the most reliable and often used is a nation’s gross domestic product (GDP). Investor confidence in rising GDP figures often results in rising stock prices which can lead to more buying activity. But the relationship between the stock market and the economy may not always be a true indicator of a nation’s well-being.
Popular indexes such as the S&P 500 are now dominated by technology stocks, which performed very well in 2020 with everyone stuck at home for work and for play. Meanwhile, industries heavily impacted by the pandemic, such as the travel and hotel sectors, saw related stocks plummet. The latter sectors also saw job losses as they could not operate business as usual. Can one then say the economy was doing well just because some stocks did extremely well and helped pull the overall stock market up? This is an example of why the stock markets do not always reflect ground reality.
As intertwined as technology is in our day to day lives, tech companies only form a small part of several nation’s economies but in some major economies, form a large part of the stock market. Like in the United States. Also, the stock market typically reacts on profitability, not growth. A company may announce reasonable growth or even flat sales, but if profits dip substantially, or incur heavy losses, brokers often see that as a sign to sell the company’s stock in the short term.
The reason Wall Street comes under attack from ‘Main Street’ (the common folk) is because they see stock brokers and large investments firms playing around with huge capital sums for their own benefit — and not the benefit of all. Financial advisors tend to favor stocks that will deliver high performance in the future, but this can often be speculative. Like how buzz worthy industries such as blockchain and electric vehicles currently are. But if the same underperform financially, the same advisors would recommend their investors sell such stocks to save their portfolios. This can undermine future growth of a sector, whose fundamentals could still be strong, but due to short term greed and hype cause the markets to react otherwise.
In conclusion, yes the relationship between the stock market and our economy often converges but there also times when the two depart from each other. Investors should do their research and keep the various factors in mind when making decisions regarding investing.
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