The stock market is not the economy

The stock market is not the economy, and the economy is not the stock market

By Morf Morford
Tacoma Daily Index

As we become (almost) accustomed to triple digit swings in the stock market, it might be a good time to do a little refresher on what the stock market is – and what, if anything, it means to the larger economy, or even more important perhaps, what it means to any local economy.

The stock market

First of all, the stock market is the collection of markets and exchanges where individuals and institutions can engage with the issuing and trading of publicly and privately held company stocks and equities. It is one of the most key components of our capitalist economy. It provides companies with capital in exchange for giving investors a slice of ownership.

The “stock market,” in fact might be better defined as “a market of stocks.” It is the place where individuals, businesses and retirement programs can invest in the larger economy and, if preferred, individual companies.

As a professional stock broker told me told me many years ago, the stock market is 95% psychological.

The stock market at times takes on a casino mentality where speculation or risk-aversion dominate.

The highs or lows of the stock market may have little relevance to the larger, more hands-on, buying and selling of the tangible economy where the average person buys or sells – or even, in some mythical fairy-tale setting – saves.

The economy

An economy encompasses everything in the production, consumption, and trade of goods and services – from individuals to corporations to governments. An economy can be local, regional or global – or any combination of these.

No two economies are the same because they are specific to a region’s culture, laws, history, and geography. They are in constant flux, ever-changing and all-encompassing.

To use real estate as a template – location is everything. One aspect of the economy, at one location, for a season, may flourish while a similar business across the street or across town, or a month later might flounder.

A particular item might sell at a premium one month, and six months later can’t even be given away. Anyone remember Fidget Spinners?

The stock market can be just as fickle.

But other than a few investors – and your 401(k), does anyone really care what the stock market does, especially on a daily basis?

About a quarter of my retirement portfolio is in the stock market – and yes, the last time I looked, it had lost about $7,500 from the end of September to the end of December.

That loss, (about 10% for the year) though substantial on paper, doesn’t bother me very much for two reasons; first, most of my retirement savings fund is out of reach anyway (though I could get it if I absolutely needed it) and second, for the most part, our economy, especially our local economy, has been on a steady incline for about ten years.

Yes, a few unexpected (and unnecessary) assaults  like Brexit and impulsive and unpredictable tariffs have hit our economy  (or at least some sectors of it) and our national debt (again unnecessarily) is climbing into inconceivable heights by the minute, our underlying foundational elements, for the most part, are fairly healthy.

These road signs, with explanations in Russian, will help you navigate the gyrations of the stock market as well as any of the major business magazines. Photo: Morf Morford

These road signs, with explanations in Russian, will help you navigate the gyrations of the stock market as well as any of the major business magazines. Photo: Morf Morford

With prudent economic polices and leadership, we should be on relatively solid ground for the next year or so.

There are countervailing opinions of course – and I am glad to see them (like Forbes – https://www.investmentwatchblog.com/todd-horwitz-i-expect-a-very-rough-2019-that-may-see-us-stocks-tank-20/).

Forbes, and most other major financial journals completely missed the Great Recession (check out online or print editions of the major business magazines in September and October 2008).

You may call me a cynic, but when I hear glowing projections on the economy from the media, the Fed or politicians, I start getting a bit queasy. As long as a few (or more than a few) financial “experts” project negative returns on the stock market, I take (a little) comfort knowing that someone is keeping an eye on the economy.

And there is always the possibility of an unexpected uptick in The Market – here are just a few “improbable” though entirely possible variables – https://www.investmentwatchblog.com/kass-10-surprises-which-could-spike-the-market-5-in-one-day/.

It is crucial to remember how wrong conventional wisdom can consistently be. Uncertainty will persist, if not prevail, and we must continue to expect the unexpected, and prepare for the unpreparable.

Disasters and Black Swans (to use Nassim Taleb’s term) will certainly come upon us and give us thousand year floods every other year or record breaking fires or crop failures, but projected catastrophes also don’t arrive.

But the wild flailings of the stock market are the reminder of what the stock market is; The Dow Jones Industrial Average (DJIA) (1*), or simply the Dow, is a stock market index that indicates the value of 30 large, publicly owned companies based in the United States.

In other words, it is an “average.” If one company rises or falls, it impacts the total. Your stock participation might be out of the Dow entirely, or it might be the one that falls when the other ones rise, or the one that rises when the others fall.

Never forget that averages are inherently misleading. When I was teaching I would often use this example; take a classroom of perhaps 24 students. With twelve months in a year, wouldn’t it make sense to presume that, on average, approximately two of us were born in any given month?

It seems reasonable, but, based on my experience, it is always wrong. Almost every time I have done this exercise, four or five births are clustered in some months (usually August and September) while at least one month has zero births.

Another example of how deceptive averages can be is the statistical oddity of how with 365 days in the year, in a typical group of 25 or so, it is a near certainty that at least two people of the 25 will share a birthday.

I mention this because some investors take the swings of the Dow as if they were some kind of economic pulse or even one of the “vital signs” of our economy.

Besides, the Dow is also heavily weighted toward the “industrial” aspects of the economy. To put it mildly, it has been a few years since the US economy has been led or defined by large industrial companies.

In other words, the Dow, in spite of its near-mythological status, is not representative and has little relevance to the financial health or stability of any one of us.

In short, don’t worry about the Dow, it reflects our mood – or at least the fears and hopes of some – for that moment.

To paraphrase a classic political slogan, all economies are local.

If the Dow-Jones swings make you nervous, take a deep breath and support your local economy.

 

(1*)   https://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average