HFM information and reviews
HFM
96%
FXCC information and reviews
FXCC
92%
FxPro information and reviews
FxPro
89%
FBS information and reviews
FBS
88%
XM information and reviews
XM
86%
Exness information and reviews
Exness
86%

Does the Stock Market Reflect the Real Economy?


The stock market has often been regarded as an indicator or predictor of the real economy. Its suggested that a large downward movement in the stock market (20% and below) is telling of a future recession. Meanwhile, a large upward movement in stock prices hints toward future economic growth. However, this notion doesn’t exist without its controversy. Sceptics point towards events that questions the stock market’s supposed predictive ability of the real economy. A leading example is the strong economic growth that followed the 1987 stock market crash.

Moreover, the recent Coronavirus recession, that saw the U.S. economy contract by 19.2% from its 2019 peak, also led to a substantial rise in the S&P 500 during the same period.

Then again, the hypothesis has held true at other points in history. Steep market declines that preceded the Great Depression of the 1930s, along with the Great Recession of 2008 are both leading examples.

Nominal GDP Growth Versus S&P500, 1947- 2019

Nominal GDP Growth Versus S&P500, 1947- 2019

Looking at the past, it’s obvious that the relationship between the financial economy and the real economy definitely isn’t a clear one. At least not as clear as economists might think. The argument that posits a close relationship between Wall Street and Main Street is as follows.

Higher Returns, Higher Spending, Higher Growth

This argument, known as the Wealth effect, puts forward the idea that individuals increase their spending when the value of their held assets (such as real estate or stocks) are rising. This increase in economic activity, in theory, contributes to higher economic growth. Traditional financial models suggest that the financial markets reflect expectations about the economy. This offers predictive power over its future.

The idea is that current stock prices reflect the future earnings potential of corporations, which in turn, is directly linked to economic activity and fluctuations in the economy.

Fluctuations in stock prices are therefore thought to lead the direction of the economy. For example, if an economic recession is on the horizon, investors will anticipate this by bidding down the price of stocks.

Is the Economy/ Stock Market That Simple?

Unfortunately, it isn’t. The affiliation between the financial and real economy has never been a simple one.  Whilst it’s generally accepted that the two move in a similar direction, they often perform differently to one another. This is particularly true in the short term. This divergent relationship comes down to several factors. First, stock market investors are forward thinking by nature. The price investors are willing to purchase a stock at today is based upon future expectations of a company’s financial performance. In contrast, economic data observes what has already taken place. Economic indicators like unemployment and GDP tend to lag the broader economy. Conversely, the forward-looking landscape of the stock market often causes it to lead to economic cycle. This can be visualised in the chart below.

Economic indicators like unemployment and GDP tend to lag the broader economy

An additional point to consider is how investors digest economic headlines. Economic news can either be good or bad, but what’s more important is how this news is translated and applied.

For example, positive news of lower unemployment and higher consumer spending indicates rising economic growth. For the stock market, investors could translate this news as the onset to higher inflation– leading to rising volatility in stocks.

Other times, bad economic news can be good for markets. For example, consider the scenario of rising unemployment. This can raise market expectations for governments to respond with policies to help stimulate the economy. Generally, expectations of higher stimulus in the future are an encouraging sign for investors, often boosting the financial markets.

The Correlation Isn’t Perfect, But It Is Increasing

No one would argue that the stock market and the real economy are the same thing. However, the distinction between Wall Street and Main Street is becoming increasing harder to draw, according to analysts. Household ownership of stocks have scaled to new highs in recent decades. In 2021, the share of household wealth that came from held stocks reached a record 41.9%. This has more than doubled from 30 years ago.

“Consumers have been big buyers of equities ever since 2016. We’ve seen a really big correlation between equity prices and discretionary spending,” remarked Steve Blitz, chief U.S. economist at TS Lombard.

If the financial markets can, even vaguely, uncover the direction of the economy, the sell-off taking place now strongly argues the case for a slowing economy. The mistake is to assume the stock market and real economy are interchangeable terms. Taking the COVID-19 economy as an example, the financial markets swiftly entered a recovery, powered by the internet and tech sectors that drove the ‘stay at home’ economy.

Energy and consumer discretionary sectors, both of which are arguably more telling of the real economy, still trailed for an extended duration of the pandemic. In parallel, real GDP growth remained negative. Therefore, the lesson is simple. We should not mistake the recent performance of the equity markets as representative of the economy as a whole.

#source


RELATED

Forex Vs. Stocks - What are the Differences?

In the Olymp Trade platform, traders can choose Stocks or Forex trading mode, each optimized for their respective trading instruments. The fundamental difference between...

How Panic Works In Stock Markets And How To Deal With It

We can recall dozens of examples of panics in the markets when in a few trading days with a loud chuckle whole states went into the mire of market volatility...

Why you need a forex trading plan

A forex trading plan is a comprehensive strategy that outlines the trader’s approach to trading the forex market. It covers all aspects of trading, including the trader’s goals...

HF Markets Enhances Its HFcopy Trading Platform for Enhanced Trading Synergy

HF Markets has announced significant upgrades to its HFcopy program, catering to both Strategy Providers (SPs) and Followers, thereby solidifying its position as a premier copy trading platform...

Trading Guide to TSLA: NASDAQ - All You Need to Know About Tesla

Tesla is regarded as one of the most visionary and innovative tech companies of our time. Here’s everything you need to know about TSLA, including company history...

Stock trading: Advantages of trading shares

Start trading global shares through circus platform, which is a modern and well-developed platform that can assist you in navigating the whole trading process...

Litecoin records 4% gains

On February 26, only Litecoin and Ethereum amongst the 10 most valuable cryptocurrencies in the global market managed to record daily gains...

What Is the S&P 500 and how to trade it?

The Standard & Poor's 500 Index, known by its shorthand as the S&P 500, is arguably the most important stock index in the world. It's made up of 500 companies, including many of the largest...

3 Tips on How to Take Advantage of Volatile Markets

What’s your first reaction when market prices suddenly go tumbling down or climb up? In any case, as a trader, you’ve probably experienced market volatility in a number of situations...

IronFX: Do IBs have a regular broker access?

When choosing to be a part of something, we usually consider the reasons that would make us want to join. Maybe it’s the people involved, or trustworthiness...

A concise guide on investing in Ripple CFDs

Before the advent of digital currencies, man has been using paper or fiat currencies which are controlled by governments or central banks, restricted by location...

Coronavirus pandemic: Three scenarios on the global markets

Markets require central banks to take regulatory responses, and after the chaos that occurred last week, the expectation of such measures was quickly taken...

Coronavirus COVID-19 pandemic possible scenarios

Epidemiologists at the University of Minnesota continue to do their research on Coronavirus COVID-19. They recently published a report in which they...

When is the best time to buy Bitcoin?

Should you buy Bitcoin at $20k or wait for an even bigger drop? There are many arguments in favor of not postponing the purchase of the flagship crypto...

Unlocking The Power Of Correlation In Forex Trading

Correlation plays a crucial role in forex trading, providing valuable insights into the relationship between currency pairs. By understanding and analyzing correlations...

Trading GBP vs Euro Characteristics

After almost two decades of forex history, the GBP vs Euro pair is today one of the important major currency pairs in online trading. Both the Euro...

What is tokenomics? Understanding the token economy

With thousands of cryptocurrencies available, traders are beginning to think to themselves "What makes one crypto more valuable than another?" Tokenomics will help make sense of this.

Crypto Staking Explained And In-Depth Guide

Crypto staking has become more of a buzzword recently in the industry, however, it isn't exactly a new term when it comes to cryptocurrencies. The recent hype surrounding...

New York Stock Exchange (NYSE): Defined & Explained

The New York Stock Exchange (NYSE) appeared 231 years ago, immediately changed the US market, and became the largest marketplace for buying and selling assets in the world...

Advantages of Forex vs. Stocks

The Forex market is the largest financial market in the world, with an average daily turnover of more than $5 trillion. That's more than the stock...

Vantage information and reviews
Vantage
85%
FP Markets information and reviews
FP Markets
81%
IronFX information and reviews
IronFX
77%
T4Trade information and reviews
T4Trade
76%
Just2Trade information and reviews
Just2Trade
76%
FXNovus information and reviews
FXNovus
75%

© 2006-2025 Forex-Ratings.com

The usage of this website constitutes acceptance of the following legal information.
Any contracts of financial instruments offered to conclude bear high risks and may result in the full loss of the deposited funds. Prior to making transactions one should get acquainted with the risks to which they relate. All the information featured on the website (reviews, brokers' news, comments, analysis, quotes, forecasts or other information materials provided by Forex Ratings, as well as information provided by the partners), including graphical information about the forex companies, brokers and dealing desks, is intended solely for informational purposes, is not a means of advertising them, and doesn't imply direct instructions for investing. Forex Ratings shall not be liable for any loss, including unlimited loss of funds, which may arise directly or indirectly from the usage of this information. The editorial staff of the website does not bear any responsibility whatsoever for the content of the comments or reviews made by the site users about the forex companies. The entire responsibility for the contents rests with the commentators. Reprint of the materials is available only with the permission of the editorial staff.
We use cookies to improve your experience and to make your stay with us more comfortable. By using Forex-Ratings.com website you agree to the cookies policy.