Tags: Economy | stocks | PE | S&P 500

Why Stocks Don’t Reflect the Economy

By Sean Hyman   |   Monday, 11 Mar 2013 07:38 AM

There is a myth out there that just drives economists batty. Their thinking is that whatever the economy is doing should spillover into the stock market and be reflected there as well. They’re always mystified when it doesn’t work this way.

So today, I want to take a few moments and dispel the myth.

Here are three main reasons why economics isn't an accurate reflection of what the market is doing or will do.

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1. We're buying companies, not economies. So if companies manage their debt, cash, resources, etc. better than the overall economy, then stocks can go up while the economy does not.

It's similar to why I can prosper in a bad economy, because I run my personal finances differently than the overall macro economy. The same can be done with a company and with large companies collectively too. So the fiscal debt and its drag on the economy can be very different than a corporation’s debt level.

2. Corporate earnings are stronger now than in times past, even though the U.S. economy is still weak. In other words, the overall earnings of companies in the Standard & Poor’s 500 are greater this time around as the S&P 500 index nears its previous tops from 2000 and 2007. We know that because of the price-earnings (P/E) ratios at the previous market peaks.

In 2000, the S&P 500 peaked at a P/E of 29, while in 2007, it peaked at a P/E of 26. Today, the P/E, while at the same level as before, is at a P/E of 17.5. Big difference. So that means that there's a lot more in earnings this time around as these companies have hit these levels. Therefore, stocks could go higher than in the past due to the state of corporate earnings even though the economy is still somewhat weak.

3. The final reason why what's going on in the U.S. economy isn't reflective of what is or will happen in stocks is that most of the companies (if not all of them) in the S&P 500 and Dow Jones Industrial Average, etc. have very significant international operations that are affected by those economies as well as our economy.

In fact, much of their growth and expansion is into foreign economies. So what these other economies are doing plays a big role into what happens in these large U.S. stock indices these days too.

Now I’m not saying that the economy has no impact on the stock market. It does. I’m just saying that if you think the economy’s direction and the direction of the stock market will travel in lockstep with each other, you’ve got another thing coming.

Look at how our stocks have soared over the past 2 ½ years or so. Is it because our economy is vibrant? Heck no. Our gross domestic product growth has been slowing, not speeding up. Yet stocks have risen.

And it’s this way in other economies and stock markets too. For instance, Japan has one of the best-performing stock markets in the world this year. Is it because Japan’s fundamentals are among the best in the world? Heck no!

What about economies like Spain and Italy? Are they in tip-top shape now? Oh gosh no! But if you look at what their stocks have done since the middle of last year, you’d think they were all back booming again economically. But we know from the economic data that this is not true.

So remember, what the economy is doing does NOT accurately reflect what stocks will necessarily do. It doesn’t mean to ignore what the economy is doing by any means. There are times, obviously, when the economy turns southward and takes down companies’ stock prices with it. No doubt.

But just never resolve in your mind that a down economy equals a down stock market and that an “up” economy means an upward stock market.

OK, as I leave you today, I’ll give you one more “bonus reason” why the economy and stocks don’t act the same.

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Investors are always attempting to be forward-looking. That means if they feel that the economy is going to turn around six months from now, they’ll buy up stocks now while they are still cheap. After all, when it becomes obvious that a recovery has happened, the deep values in stocks are all gone. So this always keeps the stock cycle preceding the economic cycle.

If you’d like to get in on the parts of the economy that are going to turn up next, then come check out what I’m doing in the Ultimate Wealth Report. I’ve got some picks that are primed and ready for the next wave of economic advancement to come and it’s not too late to still get in them now.

In that newsletter advisory service, I “look ahead” and buy beaten down, contrarian plays that are undervalued and set to rise significantly as those sectors begin their recoveries. So come join us at www.ultimatewealthreport.com.

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.

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