When we think of financial health, a few things might come to mind. We may think of our own financial situation, 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 on some level, they do not necessarily move in tandem, nor do they always indicate the health 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 a gauge for each other. However, the stock market does not necessarily 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? Below, we outline the major differences between the stock market and the economy and why one can progress while the other tells a different story.
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.”1 More specifically, one way we can understand economic activity is through real GDP (gross domestic product), which measures the value of goods and services while factoring inflation into the equation. As a result, 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.2
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 such production. With more individuals employed and gathering paychecks, more people have money to spend on such goods – increasing overall consumption – creating a linkage between GDP growth and declining unemployment rates. Sometimes, however, GDP can grow but not quick enough to create more jobs for those who are unemployed.2
What Is the Stock Market?
The stock market can be defined simply as “a stock exchange.”3 It is the buying and selling of ownership shares in a corporation.4 The stock market is comprised, therefore, of the buyers and sellers of shares and is not necessarily indicative of every business, worker and family.
Generally, stocks trade on expectations of future earnings of the companies on the stock exchange. 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).5
The Stock Market vs. The Economy in the Context of COVID-19
At times, the stock market and the economy can display very different pictures of economic recovery. One such example is with COVID-19. With respect to the stock market, the major indexes including the S&P, the DJIA and the Nasdaq Composite index all have surged since the market downturn in March.6 In fact, the NASDAQ is currently trading at all-time highs and the S&P has completely recovered to its pre-COVID levels while the DJIA is still about 3% below its highwater mark in February. On the other hand, GDP decreased by 4.8% in Q1 and 32.9% in Q2 and the unemployment rate skyrocketed from under 4% at the beginning of the year to 14.7% in April and currently stands at about 10%. 7,8 Why is there such a disconnect? A few reasons below.
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 is largely made up of companies that are larger and have access to broad capital markets that smaller companies do not have access to. Much of the unemployment in the U.S. currently can be found in small businesses (particularly in the retail, travel, leisure and hospitality sectors). It is important to remember that small business create nearly 50% of the jobs in the U.S.
The stock market’s performance as a whole only represents a portion of the U.S. employment market. A study conducted by the National Bureau of Economic Research showed that the wealthiest 10 percent of households in the United States were in control of 84 percent of the total value of stock shares, bonds, trusts and business equity and over 80 percent of non-home real estate. This was true despite the fact that half of all households owned a portion through mutual funds, trusts or various pension accounts. Therefore, the stock market is not necessarily a good indicator of the economy as a whole.9
It’s long been understood that at times, investors may be driven by emotional or reaction-based decision-making. As a result, their behavior may not be mimicking the economy’s current state nor affairs happening in real-time but be based more on the fear of missing a market upturn.
While the stock market may reflect changes in the economy and vice versa, the status of one does not always show the entire portrait of the other. At times, they can tell entirely different stories, as is the case with COVID-19. As always, maintaining a diversified portfolio that spreads your investment portfolio among different asset classes which respond differently to economic and market conditions is the most prudent approach to long-term investing.
Give our office a call if you have questions about your own financial situation or portfolio. Your Atlanta Financial team is always happy to talk to you and address any questions you may have.
Investment advisory services provided by Atlanta Financial Associates, LLC. Past performance may not be indicative of future results. Indexes are no available for direct investment. Securities investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.