Should We Watch the Stock Market or the Economy?

Jesse W. Hurst, CFP®, AIF®

July 14, 2021

There are many times when what is going on with the economy looks very different from what is going on with the stock market. We only have to look at the last few years to see this in action.

In calendar year 2018, we had economic growth in the United States economy of 2.93%, as measured by GDP. This was one of the strongest years we have experienced since the Great Financial Crisis of 2007-08 and was also a .56% increase from the previous year. So, most people would expect that the stock market would have done similarly well. They would be wrong. A quick check of the facts shows that the S&P 500 dropped -4.4% that year.

By contrast, GDP grew in the United States by 2.16% in 2019. This was relatively disappointing and was also a .77% decline from the previous year. However, the United States stock market responded by going up +31.5%. The disconnect between the two is confusing to many.

So, what exactly is going on? The stock market is a leading economic indicator. It is one of ten such indicators in the government’s LEI, the index of Leading Economic Indicators. This means that the stock market is generally moving down before a recession starts. It is also typically moving higher before a recession ends. This explains why the stock market bottomed in March of last year, in the midst of the COVID-19 coronavirus shut-downs and a policy induced recession. The stock market sniffed out that massive stimulus from the Federal Government and the Federal Reserve Bank was going to eventually cause an upturn in the economy and consumer spending, therefore sending corporate profits higher. The stock market moved up well before the economy bottomed.

So, where does that leave us today with the economy booming and the stock market near all-time highs? As you can see in the chart below from our friends at ClearBridge Investments, economic growth forecasts are projecting that the second quarter of this year is likely to be one of the strongest in recent U.S. history. The economy seems to be firing on all cylinders, as all 12 indicators of their Recession Risk Dashboard are flashing green or GO!!

Source: ClearBridge Investments.

What does this mean for future stock market returns? A second chart shows that historically when economic growth is strong, stock market returns are generally positive, albeit punctuated by more periods of volatility. This comes as many investors are wondering when the party will end. The key is to look for early warning signs that economic growth is starting to deteriorate and show early indicators of when the next recession may be. This is nowhere on the horizon presently, and we must remember that no one can accurately predict geopolitical risks and economic shocks such as 9/11 or COVID-19.

Source: Bloomberg, FactSet.

We thought this was an important perspective to share. Having a good understanding of historical context gives us a lens through which to view the future. These are critical things to remember as we continue “Moving Life Forward” together. Please let us know if you have any questions about what this means for your unique situation. Have a great day!!

The views state in this commentary are not necessarily the opinion of Cetera Advisors LLC and should not be construed directly or indirectly as an offer to but or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.