One phrase that drives me crazy is when people say “the stock market is not the economy!” to any analysis that involves stocks and Gross Domestic Product (“GDP”). I think the reason it bugs me is that it implies a comparison between the two is somehow invalid.
Of course the stock market is fundamentally different from the real economy. But it’s also not illegal to compare apples and oranges. Even though that phrase implies something wrong is being done, no one is going to arrest you for doing it.
I think relationships between two fundamentally different concepts can provide valuable insights. So, let’s take a look at the forbidden fruit - the relationship between stocks and real GDP:
Prior to creating this fun scatter plot, I did a bunch of correlation analysis to find a good fit between the data sets. I settled on annual changes (e.g. 2019Q1/2018Q1) in real GDP and the average level of the S&P 500. I also took a one quarter lag of the S&P 500, as stocks tend to be a leading indicator (i.e. investors assess forward looking conditions of the markets and economy and will buy more (or sell) depending on what they are predicting in advance of it occurring).
While it’s true that the stock market is a financial metric and not an economic metric, there is definitely a relationship with GDP. To say there isn’t would imply that the correlation between the two is zero! If someone said, “hey, next quarter GDP is going to zero” then you would expect stocks to react. That is a relationship, even if it’s not perfect.
Stocks can of course deviate a great deal in comparison to the underlying real economy. A stock market bubble is a perfect example of that kind of that disconnect. On the other hand, we also wouldn’t expect stocks to perfectly correlate with GDP, because intrinsic value may not be exactly equal to the underlying economy. An example here would be multinational corporations versus US real GDP.
I guess all of this is a long-winded way of saying, I don’t like that phrase because it implies things are black and white. It doesn’t have to be that stocks have nothing to do with the economy or everything to do with the economy.
A nuanced approach is useful. Because, even when we don’t have a direct relationship between two things, we can still learn a great deal through comparative analysis.