People often say that the stock market is a leading indicator for the economy. And it is, that is until it isn’t. The market is a leading indicator in so much that current prices can be influenced by expectations of future economic growth. Of course, those expectations can simply be incorrect.
The huge 90% + stock market rally since 2009 was driven, at least in part, by expectations of an aggressive economic recovery. Consensus thinking on Wall Street was that the US would see a strong recovery similar to those coming out of prior recessions. However, as I have been writing, economic growth could very well disappoint lofty expectations, and if so stocks may be priced for disappointment as well.
Indeed, second-quarter GDP growth was just released last Friday at an anemic annual rate of 1.3% (many Wall Street analysts were calling for two and even three times that level earlier this year). Meanwhile, the market has been busy playing catch up to economic reality — trading down for seven days in a row.
The point is, it seems too simple to believe that a stock market rally necessarily equates to economic growth. Instead, I think it makes much more sense to evaluate the economy on the merits of its own fundamentals, independent of what the market “thinks.”
When the market’s expectations seem to be off base (which happens more than we think), stick to the facts and forget the frenzy. For example, at some point, the market will be priced for economic ruin with the masses calling for doom and gloom. I would not be surprised to see it come at a time when economic conditions are actually improving.
And though it will probably be difficult to play the contrarian at first, just keep in mind that the market will likely be playing catch up in the end.
Victor K. Lai, CFA
This blog is for informational purposes only. Nothing on this blog constitutes investment advice. Bellwether Capital Management LLC does not provide tax or legal advice. You should conduct proper due diligence and/or consult with your professional advisers before taking any investment action.