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August 26, 2020

FBS, Why US stock market and US economy aren't correlated directly?

How S&P 500 is performing well while US Economy is showing devastating result?

Why-US-stock-market-and-US-economy-aren't-correlated-directly Why-US-stock-market-and-US-economy-aren't-correlated-directly

Why you shouldn’t measure US economy’s health with Stock Market

Do you know differences between stock markets and the US economy?

People often confuse the stock market with indicators of the US economic well-being.

However, there are a several key differences between the two — here they are.

  1. Some stock indexes are more focused on the manufacturing sector (S&P 500 for example), while the GDP is more services-driven. A services economy, of course, would be more damaged and harder hit as people were forced to stay at home during the lock-downs so the hit to the S&P would be related to the damage to the entire US economy. But any conclusion based on a direct link between the two should be taken with precaution.
  2. The S&P 500 is more investment-driven than consumption-driven. Therefore, the index hasn’t been hit as badly as the US economy was as the latter relies on consumer spending and hence, consumption.
  3. The S&P 500 is a global index, while the GDP is a domestic indicator. Roughly, 40% of the S&P tech companies’ sales come from the international market. In the meantime, the part of the exports in the US GDP is only 13%. In a nutshell, the US economy is a net importer, while the S&P 500 is a net exporter.
  4. The S&P 500 would prefer seeing higher oil prices because it consists of companies that make profits from it. On the other hand, the US GDP would rather have cheaper oil that favors consumer spending. Therefore, although the US domestic economic layout is definitely related to the stock market, and the S&P in particular, both have to be clearly delineated as they reflect very distinctive entities.

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Why are stocks up and soaring amid a global pandemic?

Don’t deny, we all have wondered about the same thing, how do US stocks continue to break records and bring fantastic profits, while the US economy suffers from coronavirus?

The answer is simple, stock markets and indices aren’t the mirror of the economy.

The world is experiencing the worst pandemic in 100 years, and the United States is facing one of the most severe recessions since the Great Depression.

However, the S&P 500 has risen by more than 50% from its lowest level in late March, even after losing a third of its value at the beginning of the pandemic and the market crash that followed it.

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1. Effective vaccine on Coronavirus

Everything ends, and so does the Coronavirus pandemic.

Markets are always looking into the future and see the bright days ahead.

Stock markets are confident that this pandemic will go away soon, no matter how long it takes, especially with the positive news about an effective vaccine or even several ones.

If the vaccine is widely distributed late this year or early next year, this means that life may return to normal sooner than expected.

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2. Low interest rate

Yes, stocks are undoubtedly expensive, but they look cheap compared to the US Treasury yields.

Lower rates support stock prices, and this will help raise its value when calculating future gains.

3. Massive Monetary Stimulus from the FED

The stimulus from the Federal Reserve increased the money supply in the US economy.

Some of that money has found a home in the stock market.

Throughout history, money supply growth and stock prices have always moved side by side.

The more money they pump into the markets, the higher the US stock prices get – this certainly happened over the past months already.

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4. The winners from the Coronavirus crisis are the biggest

“Stay-at-home stocks” have boomed during the global quarantine.

We saw it in the earnings reports from some of the tech giants like Amazon, Google, and Facebook.

Besides, about 40% of the companies included in the “S&P 500” index are classified as technology, digital media, or e-commerce, which provide services that made our lives easier during the coronavirus crisis.

Also, don’t forget the vital companies that life can’t go on without, such as consumer staples, telecommunications, and utilities.

Therefore, these companies will continue to generate profits and increase their market value in these exceptional times.

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5. The S&P 500 performance doesn’t represent the US economy

There are differences between the stock market and the US economy.

For example, the S&P 500 is driven more by manufacturing, while the US GDP is driven by services.

Of course, the service sector was hit harder due to social distancing rules and lock-downs that forced people to stay home.

Consumer spending accounts for more than two-thirds of US economic activity.

The S&P 500 is a global index, while GDP is considered a domestic one.

About 40% of the sales of tech companies listed in the “S&P 500” come from abroad.

Whereas, exports represent only 13% of the US GDP.

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Conclusion

Higher stock prices during recessions are a common occurrence.

Stock prices have risen in 7 of the 12 previous recessions, by an average of 5.7%.

That’s why we don’t think the stock market is in a bubble or that Wall Street investors are too stubborn to see how bad things are in the US because of the coronavirus.

The situation, of course, is very dire now, but it will improve in the coming year.

That’s what matters to investors – the future.

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