The Stock Market vs. The Economy | Summary and Q&A

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April 22, 2020
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Ben Felix
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The Stock Market vs. The Economy

TL;DR

Economic data does not directly impact stock market returns, as the stock market is forward-looking and takes into account future expectations. Short-term stock price changes are driven by unexpected economic events, while long-term economic growth does not necessarily lead to higher stock returns.

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Questions & Answers

Q: Why does economic news not always impact stock market returns?

The stock market is forward-looking and already incorporates expectations about the future into stock prices. Economic news that is released as anticipated would not have a significant effect on stock market returns. Only unexpected economic events drive short-term changes in stock prices.

Q: What was the relationship between the US stock market and the economy during the global financial crisis?

The US stock market started declining two months before the official announcement of the economic recession, and unemployment and GDP data continued to worsen even after the stock market bottomed out. This shows that the stock market's performance is not directly tied to the state of the economy.

Q: Does economic growth lead to higher stock returns in the long-term?

No, there is a negative correlation between economic growth and stock returns. Investors tend to overpay for expected growth, and the slippage effect, where new share issuances dilute earnings per share growth, can lead to disappointing investment returns. Countries with faster economic growth may not necessarily have higher stock market returns.

Q: Should investors pay attention to economic data when making investment decisions?

Economic data should not play a role in informing investment decisions. If economic data makes it difficult to stick with a well-thought-out long-term investment plan, it may be best to ignore it altogether. Stock market returns are driven by expectations about the future, not economic data.

Summary & Key Takeaways

  • Economic news, such as unemployment or GDP data, does not have a direct impact on stock market returns, as the stock market is forward-looking and already incorporates expectations about the future into stock prices.

  • Short-term stock market returns are driven by unexpected economic events, regardless of whether the news is good or bad. Only economic news that is better or worse than expected leads to significant short-term changes in stock prices.

  • Long-term economic growth does not necessarily result in higher stock returns, as investors tend to overpay for expected growth, and earnings per share growth may not keep up with GDP growth due to new share issuances.

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