For Mark Roberts’ Use:
Economists often expect that the condition of the economy will be reflected in the stock market. When things don’t work out this way, it causes quite a bit of frustration and confusion. There are three main reasons that this way of thinking is a huge misconception:
Investing in the stock market involves purchasing companies, not entire economies. If a company is succeeding at debt and resource management, even though the general economy is not, then the value of stocks can rise even in a poor economy. It may help to view individual companies as being similar to households. Many households are capable of doing well during poor economic times, because they learn to manage their budgets well. Fiscal debt harms the economy, but it does not equal household or even corporate debt.
Even though the economy remains sluggish, corporate earnings are stronger than they have been in the past. As the S&P 500 index comes close to its previous highs from 2000 and 2007, stocks could go even higher due to the state of corporate earnings. This can be seen when analyzing the price-earnings (P/E) ratios from 2000 and 2007, and comparing them to current P/E ratios. When the S&P 500 peaked in 2000 it carried a ratio of 29, and then a ratio of 26 during the peak of 2007. In 2013, S&P is peaking with a P/E ratio of only 17.5, meaning earnings are even greater this time around.
Most companies in the S&P 500, as well as those in the Dow Jones Industrial Average, are not operating only within the U.S. economy. Their substantial international operations mean that these companies are also affected by economies in other countries. It’s important to abandon common American ethnocentric views, and keep in mind that the U.S. economy is not the only major player in the business world.
Obviously, there are times when the poor state of the economy does drag down stock prices. The important thing to remember is that they do not always work perfectly in conjunction, and therefore other factors must be considered when thinking about the current state and future of the stock market.