The stock market and the economy are closely linked in many investors’ minds. This is understandable given that media coverage often blends the two as if they were the same thing.
While the stock market may respond to economic indicators or news, it doesn’t always respond in the manner that makes sense.
The economy and the stock market have a lot in common, however the stock market is not the economy and the economy is not the stock market.
This makes perfect sense to some people, however others find it confusing and misleading.
The economy is a way of defining all we make, buy, sell and consume. The stock market is part of the economy, however its focus is very narrow, confined to securities that represent, for the most part, the largest and most robust companies.
Many times the economy and the stock market move in the same direction, although not usually at the same time.
The economy is measured after-the-fact (unemployment was down last month or exports climbed in the most recent quarter).
The stock market responds instantly to changes in the economy and/or investor sentiment. It looks forward, rather than backward. For this reason, the stock market may seem out of touch with the economy.
Stock investors bet on the future, so their sentiment may be out of sync with the economy that is always looking back. In that regard, the stock market is a leading indicator for the economy.
The economic news may be bad today, but if stock investors believe better times are just around the corner, they may begin buying, which will drive up stock prices.
This is how you can have an up stock market, but bad news on the economy in the same time period.