Does the Economy Drive the Stock Market?
The past 12 months have seen the rise of a number of issues that are viewed as threats to global economic growth. Concerns about the U.S.-China trade war, Brexit, and most recently the coronavirus outbreak have made headlines around the world, prompting ongoing speculation about how each of these issues may impact both the domestic and global economy. Naturally, this leads investors to wonder how changes to the structure and function of the economy might impact their portfolio. This is often expressed in some form of the question: To what degree does the economy drive stock market returns?
The answer, in short, is that it depends on the time frame that is being considered. Over the long run, the economy and the stock market are positively correlated. A strong economy will produce more jobs, higher wages, increased consumption, and greater business activity which ultimately benefits the companies that make up the stock market.
In the short term, however, the relationship between the economy and the stock market is much less clear. One key component of this relationship is the reality that the stock market values companies based on expectations for the future, while the economy is generally measured using data points that reflect past activities. This inherent difference is what makes the relationship between stocks and the economy so complex. It may seem like the stock market ignores the economy in some cases but swings up or down in others. While every situation is different, the important question to ask is whether or not the latest information fundamentally changes expectations for the future.
It is important for long-term investors to remember that the majority of headlines or economic updates will not change our expectations for the future. Over-reacting in the short-term is one of the easiest ways to derail a well-constructed financial plan and potentially incur unnecessary tax costs. This is why Savant consistently emphasizes investing for the long term, diversifying, and maintaining the appropriate asset allocation for your risk tolerance. If you ever have questions about how current events may or may not impact your portfolio, we encourage you to reach out to your financial advisor.
Sources: JP Morgan and Dimensional Fund Advisors
This is intended for informational purposes only and should not be construed as legal, investment or financial advice. Please consult your legal, investment and financial professionals regarding your specific circumstances.