The Stock Market and the Economy Are Not the Same: A Guide to Understanding the Difference
When we think of financial health, a few things might come to mind. We may think of our own financial status, our investments, the Dow Jones Industrial Average performance, the stock market as a whole, the economy, the country’s employment status, and so on. While some aspects may be interrelated, they are not all the same, nor do they all indicate the status of one another.
The various ways we can characterize financial well-being speaks to why so many people think of the stock market and the economy’s health as interconnected. However, the stock market does not define economic health as a whole. As we’ve seen with COVID-19, stocks are back on the rise, but many individuals - and the country as a whole - are still facing the effects of business closures, record-breaking unemployment rates, and more. So why is this?
Here are the major differences between the stock market and the economy and why one can progress while the other may not.
What Is the Economy?
The economy can be defined as “the wealth and resources of a country or region, especially in terms of the production and consumption of goods and services.” More specifically, one way we can understand economic activity is through real GDP (gross domestic product), which measures the value of goods and services within the country while factoring inflation into the equation.
Understanding the health of the economy can be thought of in terms of the growth rate of real GDP, meaning whether or not the production of goods and services is increasing or decreasing.
Economic Health in Terms of GDP and Employment
Naturally, employment may rise as production and consumption increase. To produce more goods, companies and factories might hire more employees to complete production. With more individuals employed and gathering paychecks, more people have money to spend on goods - increasing overall consumption. Sometimes, however, GDP can grow but not quickly enough to create more jobs for those who are unemployed.
What Is the Stock Market?
In simple terms, the stock market can be defined as a stock exchange. It is the buying and selling of ownership shares in a corporation. The stock market includes the buyers and sellers (with some buyers and sellers holding more “stock” than others) and is not necessarily indicative of every business, worker, and family.
Some of the main indexes used to understand how the market is performing are the Dow Jones Industrial Average (tracking of 30 leading companies), the S&P 500 Index (500 stocks across all industries), and the Nasdaq Composite Index (a dynamic mix of 3,000 stocks across the technology, biotechnology, and pharmaceutical sectors).
The Stock Market vs. The Economy in the Context of COVID-19
The stock market and the economy can display very different pictures of “progress.” One such example is with COVID-19. Regarding the stock market, the major indexes, including the S&P, the DJIA, and the Nasdaq Composite index, have all surged since the market downturn in March. On the other hand, GDP decreased by five percent in 2020’s first quarter, and as of June 2020, the number of unemployed individuals rose to 12 million since February. Why is there such a disconnect? A few reasons.
When considering the make-up of the S&P, the DJIA, and the Nasdaq Composite index, the stock market isn’t representative of all who make up the U.S. economy. It consists primarily of larger companies that are different than small businesses, workers, and cities in the U.S., with different profits, greater access to bond markets, and global positioning.
The stock market is considered a leading economic indicator of future company returns. Overall, the stock market’s performance represents a portion of the U.S. employment market, although it spans a variety of industries. And, all industries are being affected by COVID. Some are experiencing extreme growth, and some have been impacted negatively. The net result is that there is a slightly positive return YTD. This graphic helps demonstrate.
It is understood that, at times, investors may be driven by emotional or reaction-based decision-making. As a result, their behavior may not mimic the economy’s current state nor affairs happening in real-time.
While the stock market may reflect some changes in the economy and vice versa, the status of one does not show the entire portrait of the other. At times, they can tell entirely different stories, as is the case with COVID-19. Considering other factors such as unemployment can provide a fuller depiction of the state of the economy and the financial well-being of its residents.
Erickson Braund is the Founder and Chief Financial Officer at Black Walnut Wealth Management. He is a Certified Financial Planner®️ professional and a Chartered Retirement Planning Counselor®️. Eric brings over 20 years of experience working with high net-worth individuals and families, helping them achieve their goals of protecting and growing their wealth for retirement and for generations to come. Because Eric is a CFP®️ professional, he adheres to high ethical standards and engages in at least 30 hours of approved continuing education in the financial industry each year.
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