How can so many Americans feel pessimistic about the economy while the stock market continues to rise?
It sounds contradictory, but it isn’t. The economy people experience and the economy reflected in stock prices are related without being interchangeable.
Most of us experience economic conditions personally. We know what groceries cost, whether our paychecks stretch as far as they once did, what it costs to borrow money and whether people around us are looking for jobs. Those experiences naturally shape our view of the economy.
The stock market is evaluating something different. Investors are trying to determine what businesses will earn in the future and what those earnings are worth today. Stock prices can therefore move in ways that seem out of touch with current economic news because expectations about future earnings are already being incorporated into prices.
The current market makes the disconnect particularly easy to see. Some businesses that depend heavily on household spending can struggle, while companies exposed to entirely different sources of demand continue to produce strong earnings. We talk about “the economy” as though every business and household participates in the same conditions, when they can be experiencing very different ones.
A restaurant can face customers cutting back on discretionary spending, while a company supplying equipment for a major investment cycle struggles to meet demand. A family dealing with higher borrowing costs can feel considerably worse off, while an investor whose assets have appreciated sees the same period very differently.
The trouble begins when investors take one part of that picture and turn it into a forecast for the entire market.
I’ve spent much of my career studying markets, and experience has made me skeptical of explanations that sound too complete. Economic growth slows; therefore, stocks should fall. Consumers are struggling; therefore stocks should fall. Employment weakens; therefore, stocks should fall.
The premise can be correct, and the investment conclusion can still be wrong.
Public companies are not a mirror of the average American household. They operate in different industries and countries, adjust costs, increase productivity and allocate capital in ways that can allow profits to grow even when parts of the economy are under pressure. Over longer periods, corporate earnings are closely tied to equity returns, which is one reason investors pay so much attention to what companies are likely to earn, rather than simply what the latest economic report says.
Timing complicates the picture further. A jobs report measures conditions that have already developed, while stock prices incorporate expectations about what comes next. By the time an economic trend becomes obvious enough to dominate headlines, investors may have been adjusting their expectations for months.
Our own experience can make this harder because each of us lives inside a very small economic bubble . Someone who works in real estate naturally sees the economy through housing. Someone in technology sees hiring and investment through that industry. A business owner whose customers are pulling back has very good evidence that those customers are under pressure.
The evidence is real. It just isn’t necessarily representative.
This is one reason I have spent so much of my career testing ideas against market behavior rather than relying on what seems logical. Markets have repeatedly taught me that a persuasive explanation and a profitable conclusion are not the same thing. I would rather find out what the evidence supports than put money behind what I believe ought to happen.
When the economic story seems obvious, I want to know what it means for corporate earnings, how much of it investors already expect, and whether stock prices are behaving the way the story suggests they should.
You can understand the economy correctly and still get the market wrong.
For an investor, being right about the economy is only half the job. The harder part is knowing whether your conclusion about the market follows from it.
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