The Stock Market Is Not the Economy

What’s more, the two are drifting even further apart.  

John Rekenthaler 22 May, 2020 | 9:00
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Bad News, Good News
In 1982, the unemployment rate started high and finished higher. It entered the year at 8.6% and concluded at 10.8%, its steepest level since the Great Depression. That was the first time that I had paid attention to employment statistics, because I was approaching my college graduation, and I must confess I was worried. (Correctly, as it turned out: I would not land a permanent job until summer 1984.)

To my surprise, stocks surged in 1982. The S&P 500 gained 21.6% on the year, well above its average. That made no sense to me. Not only was unemployment rising, but seasonally adjusted gross domestic product fell during every quarter of 1982. The media called it “the Reagan recession.” (It wasn’t until later that I realized presidents cause neither busts nor booms.)

What I did not know, because I was not then an investor, is that stock prices are only tenuously connected to general economic conditions. For one, stocks anticipate future developments rather than dwell on current affairs. For another, neither employment statistics nor GDP growth directly affect equity prices. The primary drivers are instead two sets of expectations: 1) future earnings and 2) future interest rates, with the latter being used to discount the former.

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John Rekenthaler  is vice president of research for Morningstar.

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