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The Economy and the Stock Market, Investments and Wealth Management

Stanford_dsc01161
(Stanford University - Alvin Wei-Cheng Wong)



The Stock Market Is Not The Economy.



- The Stock Market and The Economy

The “Stock Market” refers to the collection of markets (such as the S&P 500, the NASDAQ, or The Dow Jones) where regular activities of buying, selling, and issuing shares of publicly-held companies take place. The “Economy,” on the other hand, is the wealth and resources of a country in terms of production and consumption of goods and services and the supply of money. 

Although these two terms are often used interchangeably, they are not one and the same. They do however impact each other. For example, a strong economy can create fears that inflation is on the rise. Fears about inflation drive worries for investors that the Federal Reserve could raise interest rates faster than indicated. The worries about the Fed fuel a long-held view that rising rates kill bull markets, partly because companies tend to have slower growth when money becomes more expensive to borrow.  All this worry and anxiety can lead to a simple conclusion: Sell.

 

- Economic Indicators

Economists typically group macroeconomic statistics under one of three headings - leading, lagging, or coincident. Figuratively speaking, one views them through the windshield, the rear-view mirror, or the side window. Coincident and lagging indicators provide investors with some confirmation of where the market is and where it has been, and are a good place to start because they help indicate where the economy might be heading. 

How do we use economic indicators to help us try to anticipate the direction of the stock market? While we certainly do not have a crystal ball, we look at a variety of measurements such as GDP, employment rates, and jobless numbers as clues to where the economy is going. The consumer price index, producer price index, and retail sales are also seen as indicators of the health of the economy, by telling us how the consumer is feeling about the economy. 

Additionally, understanding the government’s use of Fiscal Policy and the Federal Reserve’s Monetary Policy is another way in which we can predict the stock market’s reaction to change. Fiscal Policy, implemented by the president and congress, is used to either pump money into a failing economy through government expenditure or take money out of the economy by raising taxes. Monetary Policy is the Federal Reserves raising or lowering interest rates for banks, which trickles down to affect what price businesses can borrow money to continue growing. 

In the end, the stock market and the economy are not the same.  However, they heavily influence each other. This relationship is something we will continue to track as we monitor the investing landscape.

 

Salem_MA_1942_n
(Salem, Massachusetts - Harvard Taiwan Student Association)

- Market Indexes

In order for an economic indicator to have predictive value for investors, it must be current, it must be forward-looking, and it must discount current values according to future expectations. Meaningful statistics about the direction of the economy start with the major market indexes and the information they provide about:

  • Stock and stock futures markets
  • Bond and mortgage interest rates, and the yield curve
  • Foreign exchange rates
  • Commodity prices, especially gold, grains, oil, and metals


Although these measures are crucial to investors, they are not generally regarded as economic indicators per se. This is because they do not look very far into the future - a few weeks or months at most. Charting the history of indexes over time puts them in context and gives them meaning. For instance, it is not terribly useful to know that it costs $2 to purchase one British pound, but it may be useful to know that the pound is trading at a five-year high against the dollar.

 

- Investment Management and Wealth Management

Investment management refers to the handling of financial assets and other investments - not only buying and selling them. Management includes devising a short- or long-term strategy for acquiring and disposing of portfolio holdings. It can also include banking, budgeting, and tax services and duties, as well. The term most often refers to managing the holdings within an investment portfolio, and the trading of them to achieve a specific investment objective. Investment management is also known as money management, portfolio management, or wealth management.

Wealth management is an investment advisory service that combines other financial services to address the needs of affluent clients. It is a consultative process whereby the advisor gleans information about the client's wants and tailors a bespoke strategy utilizing appropriate financial products and services. A wealth management advisor or wealth manager is a type of financial advisor who utilizes the spectrum of financial disciplines available, such as financial and investment advice, legal or estate planning, accounting, and tax services, and retirement planning, to manage an affluent client's wealth for one set fee.  

Investment management tends to focus only on investing assets; wealth management takes a broader approach. The former might be handled by a broker or an advisor focused solely on managing your portfolio. If you hire a wealth manager, however, he or she will typically look beyond assets to incorporate taxes, insurance, and the whole estate into the planning process.

 

- The Stock Market Is Not The Economy

The economy is complicated and it moves fast. News breaks and headlines don’t always tell the whole story. Usually, this simply means that fluctuations in the markets may have little to no real bearing on the underlying realities we think of as making up the economy. Or that there are many important structural factors that make the markets’ outlook different from how ordinary citizens view the country’s overall economic health.

In the time of COVID-19 (year 2020), the stock market couldn’t be more divorced from the United States’ broader economic situation. Although the S&P 500 tumbled sharply in March, 2020, as the coronavirus shut down large swaths of the economy, it had made back almost all of its losses by the first week of June - before dipping again and then quickly rebounding yet again.

Even beyond the markets, there has been some data to suggest that the worst fears about the economy in late March and April, 2020 were too pessimistic. But the overall state of unemployment is still quite bad by historical standards, which mirrors numerous important economic indicators that are almost uniformly down - to a significant degree - from last summer (year 2019). And yet stock indices continue to rebound much faster than the rest of the economy.

Why? As is usually the case in economics, it’s complicated - and everyone has a pet theory. A few include:

  • The idea that investors are betting on a quick “V-shaped” recovery (rather than the longer, slower “swoosh” shape many economists have predicted) and banking on corporate profits eventually rebounding in the medium and long run. 
  • Some prominent tech companies at the top of the market (such as Microsoft, Apple and Alphabet) actually have reason to think the pandemic could shift business in their favor, with so much emphasis placed on digital shopping, communication and entertainment. 
  • And the rise of algorithm-based trading has insulated markets somewhat from the shocks that could be created by big news events, such as political developments or the protests against racial injustice currently sweeping across the country, since dispassionate algorithms don’t get worried or scared by the news the way humans do. 
  • The markets are also providing a better place for wealthy people to stash their money than alternatives like bonds or banks. People, particularly the rich, have cut back their spending, so they need to park their funds somewhere like the stock market especially since interest rates are rock bottom, 
  • Inequality can mean that even with millions out of work, there might still be a glut of funds from the high-earning and/or high-wealth individuals. The yield on Treasury bonds is so low that stocks are an attractive option - even in the midst of a recession caused by a once-in-a-generation pandemic. 

 

Recent stock market performance  (July, 2020) could be more about something like a savings glut rather than optimism on the future value of companies. It may be more about the S&P 500 being better than anywhere else to put funds rather than about actual optimism. That doesn’t necessarily mean there’s no optimism driving investors’ actions, though. Maybe people are investing for the longer term and are viewing the current economic situation as substantially temporary. And it’s worth noting that, despite everything, the markets are not totally separate from the virus that continues to afflict every corner of the world. 

When news of the coronavirus first hit, the VIX - a measure of market volatility perhaps better known as the “fear index” - spiked to 82.7, its highest level ever. (The previous high was 80.9, which it hit in November 2008, when the Great Recession sparked a massive selloff.) News of a COVID-19 resurgence earlier this month caused the VIX to surge to 40.8, another abnormally high number -outside of recessions, the VIX usually floats between 10 and 20. Despite the rising indices, uncertainty rules the stock market right now. 

What that means down the line is anybody’s guess. But for now, Wall Street has shown a shocking amount of resilience even as almost every other economic indicator has tanked. If nothing else, let this be the final confirmation that, once and for all, the stock market is not the economy.

 

 

[More to come ...]



 

 

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