The stock market is not the economy and the economy is not the stock market that much is certain.
However, much beyond that things become considerably less certain. The economy typically reacts slowly and changes direction over a period of months.
The stock market on the other hand can turn on a dime and often catches the unaware looking the wrong direction.
Nevertheless, the stock market is heavily dependent upon a robust economy for sustained long-term growth across a broad range of stocks.
Long-term investors count on a growing economy to help their companies build value over time. Traders on the other hand, move when economic news causes a strong negative or positive reaction in the stock market.
In many cases, the strong reaction is a very temporary phenomenon and is often corrected by the stock market very quickly.
The booming stock market helps build consumer confidence, which in turn leads to more spending and often a growing economy.
The stock market is often a leading indicator of the economy, but not always. A sluggish economy can be a challenge for investors in the stock market, especially if the stock market is moving forward at a reasonable clip.
Which can leave stock investors with a challenge, is the economy pulling out of the dumps or is this a blip? Where should investors be looking to invest if the economy might slip backwards? If you invest in companies that will benefit from a more robust economy, but the economy retreats, you may be sorry.
The stock market is not the economy and the economy is not the stock market - as I have said on several occasions.
However, the two are very related and for long-term stock investors, the economy and its future are of considerable importance.
While stock market indexes can rise and fall seemingly independent of the economy, ultimately, the economy will affect the opportunities for companies to grow.
When the economy is booming, the stock market will go along for the ride until investors become concerned about a number of factors, including inflation, price bubbles for stocks, changes in interest rates and, increasingly global competition.
When the economy and the stock market are booming, the trick is to know when to get out or, at least, take some profits out of the market.
On the other hand, when the economy is stagnant or barely growing, stock investors must consider where to put their money. If they are long-term investors and don't need a quick profit, stock investors look to cyclical stocks, which may be under-priced, but offer potential growth as the economy improves.
Historically, the economy has not stayed stuck in a slow-growth mode for very long. However, there is no guarantee that will always be the case.
The economy is an incredibly complex system, that, despite what economists and pundits profess, we still don't know everything we should.
If you are a stock investor facing a slow-growth economy, what should you do? Here are a couple of ideas:
- First, lower your expectations. You may have to accept a lower potential return or be willing to take more risk to achieve your goal.
- Second, cyclical stocks have a good chance for reasonable gains as the pace of economic growth quickens. Long-term investors can look for cyclical stocks that may be under-priced (when considering long-term potential) for good returns when the economy picks up.
- Third, remember that the stock market is always looking to the future and not necessarily the present. It can begin moving in a particular direction before the economy does.
There are still opportunities for the long-term investor in a slow-growth economy, you just may have to look harder.