Economy vs Stock Market

One of the things I see over and over again is confusion about the relationship between the stock market and the economy. The stock market is an instrument that attempts to predict what is happening with individual companies. We have indices that lump groups of these companies under a single umbrella and these indices to some extent reflect the broader economy, but investing in the stock market is not the same thing as investing in the economy per se.

There is general consensus for example that unemployment is going to rise further before the number of jobs created overtakes the number of jobs being lost. This seems like a negative economic indicator and it certainly is. However, if companies cut costs and increase profitability while shedding jobs, they may very well become an excellent investment even as total current revenue falls. Being more productive can only lead to significant profit growth when revenue does increase.

So any individual company may become a good investment despite poor economic conditions. In fact the one thing that is true of economic corrections is that inefficient and marginal companies are forced out of business.

Now, clearly, there is a relationship between the economy and the stock market, however it is an indirect one and if you wait for the economy to be clearly better you may very well have missed the best investment opportunity.

Back in March the stock market reflected the possibility that this country was headed to another great depression. As that fear eased, it has moved to a more reasonable level and is still trying to determine the timing of the recovery. However, individual companies will reflect the prospects facing them. Yes, there are broad market trends when most stocks go up or go down, but if you look for those stocks that will benefit from the recovery earlier, or that can benefit during the current economic slowdown, you will outperform the broad market.