You may be surprised to see the stock market moving higher, despite the domestic economy struggling. How can the stock market be up if unemployment is increasing?
Aren’t the stock market and the economy the same thing? Not quite, but they are interrelated.
This resource explains the differences between the economy and the stock market, outlining how they can share similarities but are fundamentally different.
Stock Market vs Economy
The stock market is a marketplace for investors and traders to buy and sell shares in publicly listed companies. Publicly listed companies are those that let the public invest in their organisation.
The biggest stock markets around the world include the Nasdaq, New York Stock Exchange (NYSE), Tokyo Stock Exchange (TSE), London Stock Exchange (LSE) and Australian Securities Exchange (ASX).
The economy looks at the bigger picture—production, consumption and trade of a country.
There are many factors that make up an economy, including the impact of individuals, households, corporations, financial institutions and governments.
Common measures of a country’s economy include gross domestic product (GDP), unemployment rates, consumer confidence and inflation.
Read: What Is Economics?
These economic measures can contain a lot of data. They take a long time to collate, resulting in the data being released well after that variable has already changed. This is why economic measures are often referred to as ‘lag indicators’, or ‘backward-looking indicators’.
Stock market measures involve analysing simple price movements and can be accessed instantly.
Influences on the Economy & Stock Market
Although the stock market and the economy are fundamentally different, they have common influences.
Factors that have an effect on both the stock market and the economy include (but are not limited to) international politics, natural disasters, global health outbreaks, interest rates and tax rates.
Whilst there are similar influences, this doesn’t necessarily mean that they impact upon the stock market and the economy in the same way.
The Stock Market & Economy Disconnect
As mentioned, the measures of the economy are backward-looking—the data is collected on events that have already happened. In contrast, the stock market is forward-looking and based on expectations of what is likely going to happen.
This is where the disconnect between the economy and stock market begins. Economic measures can show a slowdown in GDP or a rise in unemployment, but the stock market will have already processed and reacted to these economic events.
The stock market is looking forward, with investors thinking about what might happen in the future. For example, the Australian Bureau of Statistics (ABS) might release data which indicates slowing economic growth and a rise in unemployment for the first quarter of the calendar year. This might not be released until May of that year, however.
The stock market has already reacted to what they were seeing in real time. It’s thinking about the remainder of the year, and it may expect there to be a strong recovery or predict which sectors will be impacted the most.
For example, whilst official economic data is released in May, stock market participants may have already reacted to poor labour conditions in March. This is how there is a disconnect between the 2.
Over a long period (e.g. 10 years), the stock market and economic factors will typically trend in the same direction. But in shorter time frames (e.g. 1 year), they can deviate from one another.
Australia’s GDP Growth vs ASX All Ordinaries
The below 2 graphs highlight the relationship between Australia’s GDP growth and the ASX All Ordinaries index. Economic factors such as GDP can trend with the stock market. You can see that as GDP decreases or increases, the All Ordinaries show a similar price movement.
However, there are also stages where they don’t trend together. For example, GDP contracts in January 2019 and stays there for the following quarters whereas, the stock market also contracts in January 2019, but quickly recovered.
The Stock Market as an Economic Indicator
If the stock market is forward-looking, can it be a leading indicator for the economy? Sometimes.
Because there are many variables for the economy and the stock market, it is ineffective to use the value of stocks to anticipate what the economy will do in the future.
However, it is important to be aware of what’s happening in the economy. All individuals, households and businesses can positively or negatively affect the stock market.
Understanding the connection between them can help you predict movements in the financial world and remain ahead of the curve.