How the stock market differs from and can perform differently than the economy while remaining highly dependent on the economy for its success.
Topics covered include:
- Why the stock markets in countries with lower economic growth performed better than the stock markets in countries with higher economic growth.
- How the top 5 stocks in the S&P 500 Index have the largest weighting in 30 years and what will it takes for these stocks to outperform the market.
- What are the largest contributors to U.S economic growth, most of which are not publicly traded.
- How the U.S. government and the Federal Reserve saved the stock market.
- How have stocks performed during economic recessions.
- Why it is risky for investors to be dependent on the financial prospects of the largest technology stocks.
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 298. It’s titled, “The Stock Market is Not the Economy, But It Sure Depends on It.”
The market is not the economy
The top 5 companies in the S&P 500 Index, this is a measure of U.S. large-company stocks, are Microsoft, Apple, Amazon, Facebook, and Alphabet, which is the parent company to Google. Those 5 stocks comprise 20.4% of the index. The highest level in 30 years. Their performance through April, for those 5 companies, is they gained 10%. This in the face of the worst global pandemic since 1918. The other 495 stocks within the S&P 500 are down 13% year-to-date through April. This is data according to Goldman Sachs.
Eric Levitz in the New York Magazine wrote, and it’s a little bit satirical, “A growing number of Wall Street investors and analysts have made peace with the dissidence between the market’s fortunes and their own. In their view, capitalists haven’t lost touch of reality, equity values simply no longer depend on the functioning of society. The market isn’t the economy. Capitalists don’t need it to be safe for you to leave your house or possibly for 30 million unemployed Americans to find jobs in order to make healthy profits. The next industrial revolution will be live-streamed. Come on in the S&P 500 is fine.”
Sarah Ponczek wrote in Bloomberg, “The market isn’t the economy, though it’s at least a reflection of it and a bet on what will thrive in the future. Unsurprisingly, amid a crisis bent on keeping everyone at home, bets are coalescing on companies that ease the burden of being locked indoors.”
She quoted Jack Janasiewicz, a portfolio strategist at Natixis Investment Managers. They oversee $1 trillion in assets. He said, “The eye-opener is when you when you look at the ones you’re worried about,” he’s talking about stocks within the S&P 500, airlines, leisure companies, “it’s not a big chunk of the S&P 500. It’s the old adage, where the market isn’t the economy.”
That really hits an important piece here. A lot of the stuff we’re worried about, it’s just not a big chunk of the S&P 500. So maybe we did overreact by selling off 35%.
Finally, Matt Philips of the New York Times wrote a piece titled, “Repeat After Me: The Markets are Not the Economy.” He wrote, “The stock market looks increasingly divorced from economic reality. The United States is on the brink of the worst economic collapse since the Hoover administration. Corporate profits have crumbled, more than a million Americans have contracted the coronavirus and hundreds are dying each day. There is no turn around in sight, yet stocks keep climbing. Even as 20.5 million people lost their jobs in April, the S&P 500 stock index logged its best month in 33 years.”
The top 5 companies in the S&P 500 employ about 1.2 million workers worldwide. The U.S. has 133 million employed workers. Last month, it was 156 million. Over 20 million jobs lost. Those 5 companies’ employment makes up only 0.9% of jobs. And across the entire S&P 500, those companies only employ about 17% of U.S. workers.
What other evidence do we have that the stock market is not the economy? We’re going to explore that in this episode.
The market and economy’s strange disconnect
Here’s some data from Ned Davis Research: When U.S. real GDP (Gross Domestic Product), it’s the measure of output, the dollar value of goods and services produced, when it has grown at a pace greater than 6.1% year over year, the S&P 500 has lost 4.6%. That’s going back to 1960.
When GDP growth has been below 0.8%, which would include contractions year over year, the S&P 500 Index has gained 12.1%. The stock market is better when the economy is doing poorly, according to that data set.
Here’s another piece of data. This goes back to 1948. Again, from Ned Davis Research, comparing year to year changes in nominal Gross Domestic Product, for the U.S., compared with S&P 500 earnings. Over that time frame, the U.S. nominal GDP has averaged 6.4%, annual growth, the S&P 500 has averaged 14.6% earnings growth. There is a 0% correlation, statistically, between those 2 data points. In other words, whatever GDP does it has no influence to what the earnings are doing in that given year. No correlations. Not negatively correlated in that earnings are soaring when GDP is falling, but there’s really no relationship.
In 2012, Jay Ritter, he’s an academic at the University of Florida, released a paper titled, “Is Economy Growth Good for Investors?” He went back to 1900, so 110 years of data, 19 countries and he compared real per capita, or per person, growth in GDP and the real stock returns. He found over that 110 year period that the correlation was negative. Countries with lower per capita GDP had higher real geometric stock returns.
For example, the highest return over the period was Australia, 7.2% annualized. It’s per capita GDP growth was 1.68%. The lowest return was Italy. Its real return for stock was 1.7% annualized, and it’s GDP growth was higher than Australia, 2.15%. The highest GDP per capita was Japan at 2.69%, but its real stock return was only 3.6% annualized. While the lowest GDP per capita was South Africa, 1.13%. But it’s real, the annualized stock return was 7.2%.
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