How is the Stock Market Different From the Economy?

Investing

Question of the Week
 
How is the Stock Market Different From the Economy?

Happy Five-Minute Friday, all!

I’ve talked with some of you this week about settling into the new normal of Covid-19. Some five months into the pandemic, we are all starting to realize that this is not going to be a short-term thing. As one client put it: “Life has been cancelled.”

With millions of claims with unemployment, a resurgence in Covid-19 cases and Congress not able to agree on the next stimulus package, the uncertain future is creating more anxiety and stress than ever before.

That anxiety and stress might have also caused you to worry about your investments. The economy is in shambles, so your investments have to be in the tank too, right? Turns out the market has been doing pretty well through all of this. In fact, the 50 days following March 23rd was the best 50 day stress the S&P 500 has ever had. So what gives?

In short, the stock market is not the economy. The value of the stock market reflects the expected profitability of public traded companies. In other words, it’s a prediction of how well publicly traded companies will do. This is why the stock price of companies like Zoom and Netflix have soared lately. People expect the company’s future earnings to do well, so the value of the company goes up. Additionally, that prediction may have nothing to do with the current state of the company. You’ve seen this reflected in the stock price of companies like Twitter that have a high share value, but have operated at a massive loss for years.

While publicly traded companies make up a portion of the economy, the economy includes other components like employment rates, consumer confidence, industrial production and retail and food sales.  To get a sense of how the economy as a whole is doing, you’ll have to look at all of the economic indicators.

Given the fact that the stock market doesn’t reflect the entire economy, how should you invest? Fortunately, the principles we use haven’t change. You focus on what you can control, which, spoiler alert, isn’t the stock market or the economy. It’s:

  • low costs
  • diversification
  • the amount you put into the account.

Quote of the Week

“Know what you own and know why you own it.” – Peter Lynch
Task of the Week

If you’re looking for some additional reading on the stock market vs. the economy, check out these articles:

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