Data vs speculations and assumptions: why stock markets should be viewed as an economic mirror.
There are many speculations floating around – about stock markets (that have moved away from reality and that stock markets is not economy anyway), S&P500, “Don’t fight the FED” and why so much money has been injected into the markets, “someone up there” regulates the market and profits from it, and so on…
I will try to elaborate on some of this, to see if there’s really something worthy and should I or anyone for that matter would pay attention for all this “noise”.
A while ago I wrote that markets correlate with GDP and the economy as such but recently I wanted to find a different angle to look at the market. So, I downloaded US Real GDP quarterly data and compared them with S&P500 quarterly prices. Since GDP data updates quarterly, I took the same time-frame and applied to S&P500 to see some correlations there.
For example – the GDP indicators of the 1st quarter of 2020 compared to the previous quarter are -9.09%. S&P500 also fell in the first quarter (-23.01%), which means that stock market and real economy went down at the same time. This indicates that the market movements reflected what was happening in the economy at that time. I won’t go into detail here comparing how exactly GDP moves and correlates with stock market at given time, all I want is simple view outcome where it is very clear – GDP and S&P500 are really moving in the same direction.
Still, I want to understand situations when the economy (GDP) shrinks but the stock market does not respond to it accordingly.
And then I decided to make such quarterly comparisons starting from 1947, from the year when GDP history data became available. Then I took the S&P500 data from Yahoo Finance and the results are as follows:
· GDP declines and S&P500 declines in the same quarter in 9.756% of cases
· GDP increases and S&P500 increases in the same quarter in 60.976% of cases.
· GDP increases, but the S&P500 falls by 24.83%
· GDP decreases, but S&P500 increases in 5.102% of cases
This means that the economy goes hand in hand with stock markets in 70.732% of cases. Thus, a situation where the economy is going down and the S&P500 going up is very rare, in only 5% of cases.
So, it is rather clear that stock markets CAN and MUST be viewed as an economic mirror. Because it is true in 70% of cases. Why try to go against statistics and trade against economic events? Why trade against such a high probability?
What I want to say bearing in mind all that I mentioned above – the markets are working normally. There is no "big influence from above”. 70% of the time, the market accurately reflects the economy. And all these deviations from the norm need to be studied in more depth. Is it a profit fix, or a force majeure event, or the market just simply "wrong"?