Michael D'Angelo- August 2020
When we think of financial health, a few things might come to mind. We may think of our own financial status, our investments, the stock market as a whole, the economy, the country’s employment status and so on. While some aspects may be related on some level, they do not indicate the status of one another.
The stock market does not define economic health as a whole. As we’ve seen with COVID-19, stocks are back on the rise, but many individuals - and countries 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.” 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.
What Is the Stock Market?
The stock market can be defined simply as “a stock exchange.” It is the buying and selling of ownership of shares in a corporation.
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).
The Stock Market vs. The Economy in the Context of COVID-19
The stock market and the economy can display very different pictures of “progress.” One such example is with COVID-19. In regards 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. On the other hand, GDP decreased by five percent in 2020’s first quarter, and as of June 2020, the number of unemployed individuals rose to 12 million since February. Here are a few reasons that can explain such a disconnect..
When considering the make-up of the S&P, the DJIA and the Nasdaq Composite index for example, the stock market isn’t a representation of all who make up the U.S. economy. It is largely made up of companies that are different than small businesses, workers and cities in the U.S. - with different profits, greater access to other markets and global positioning.
Also, it’s been understood that at times, investors may be driven by emotional or reaction decision-making. As a result, their behavior may not be mimicking the economy’s current state nor affairs happening in real-time.
While the stock market may reflect some changes in the economy and vice versa, the status of one does not show the entire portrait of the other. At times, they can tell entirely different stories, as is the case with COVID-19. What does this all mean? Stocks are surging and the economy is still lagging. The stock market moves in anticipation of whats to come whereas economic data is collected, processed and then reported- which means that it is based on passive information
Yes, on some aspects the economy and the stock market may be related on some level but they do not indicate the status of one another.