The Stock Market is Not the Economy

by | Aug 10, 2020 | Blog

When we think of financial health, a few things come to mind. The overall financial plan you put together with your financial planner is the most important.  What are some of the other factors besides your financial plan? Your investments, the Dow Jones Industrial Average performance, the stock market as a whole, the economy, the country’s employment status and so on. A lot of these aspects are intertwined, but they are not the same thing by any measure.  Understanding how these different factors work can make your retirement here in Monmouth County much smoother.

Financial well-being can be described a number of ways. This speaks to why so many investors think of the stock market and the economy as the same thing. However, 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 families – and the country as a whole – are still facing the effects of business closures, increased unemployment and more. So why is this? We’re going to take a look at the main definitions of the economy and the stock market.  This will help us understand how they’re different.

What Is the Economy?

The definition of the economy is “the wealth and resources of a country or region, especially in terms of the production and consumption of goods and services.” The most basic way to understand the health of the economy is through Gross Domestic Product (GDP). GDP 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 it’s increasing or decreasing.

Economic Health in Terms of GDP and Employment 

Employment may rise as production and consumption increase. To keep up with increased demand, companies and factories might hire more employees. With more people employed and getting paid, more people have money to spend in general. It’s not always a guarantee that employment will rise alongside GDP.

What Is the Stock Market? 

The stock market can be defined simply as “a stock exchange.” It is the buying and selling of ownership shares in a corporation. The stock market is made up of buyers and sellers and is not necessarily indicative of every business, worker and family. It is only indicative of those who own stock.

Some of the main indexes used to understand how the market is performing only track a small percentage of stocks. The Dow Jones Industrial Average tracks 30 of the largest companies in the US. The S&P 500 Index tracks the 500 largest companies in the US. The Nasdaq Composite Index tracks a mix of 3,000 stocks across the technology, biotechnology and pharmaceutical sectors.

How Has COVID-19 Impacted the Stock Market and the Economy?

“Progress” in the stock market and “progress” in the economy can mean two very different things. This recent pandemic is a perfect example of that. 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 5% in 2020’s first quarter, and as of June 2020, the number of unemployed individuals rose to 12 million since February. We take a look at a few reasons why there is such a disconnect.

Reason #1

When considering the make-up of the S&P, the DJIA and the Nasdaq, the stock market isn’t representative of all who make up the U.S. economy. The publicly traded companies that make up the stock market look very different from the number of small businesses all around the country who have faced a very different reality over the last few months.  The stock market is only indicative of part of the overall economy.

Reason #2

The stock market’s performance as a whole only represents a portion of the U.S. employment market. A study conducted by the National Bureau of Economic Research showed that the wealthiest 10% of households in the United States were in control of 84% of the total value of stock shares, bonds, trusts and business equity and over 80% of non-home real estate. This was true despite the fact that half of all households owned a portion through mutual funds, trusts or various pension accounts. Therefore, the stock market may not display an equal distribution between those who make up the economy as a whole.

Reason #3

It’s long 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. Considering other factors such as unemployment can provide a fuller depiction of the state of the economy.

It’s important to construct a financial plan that can weather any stock market environment and any phase of an economic cycle.  A financial planner can help you make the necessary decisions to come up with a plan you’re comfortable with.  Comfortability is key when planning your retirement here at the Jersey Shore.  If you don’t have a financial planner, we would be happy to speak with you.  Click here to schedule an appointment today.  There is no cost or obligation.

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