The era of COVID-19 and financial woes brings a question to the mind of many, Why is the stock market holding up so well when the economy appears to be struggling?
To understand why the markets react — or don’t — to certain outside factors, it’s always good to keep in mind that the stock market is not the economy. I can’t stress this enough.
The stock market is considered a “lead economic indicator. So it’s anticipating what economic conditions will look like 6-9 months into the future.1 While it can sometimes be a tricky concept to grasp, remember that the stock market’s price today reflects potential future economic activity.
Another “lead economic indicator” is building permits.2 When there is an increase in building permits, it lets us know that developers are bullish about future home sales prospects. If building permits are down, it tells investors that builders may be concerned about interest rates and consumer confidence.
Lead indicators are generally helpful, but not infallible. Abrupt and unexpected changes can prompt lead indicators to recalibrate their expectations for the future. Look no further than when COVID-19 grabbed the headlines in early March, which ended the stock market’s 11-year bull market.3,4
Keep in mind that in addition to lead indicators, there are lag indicators and coincident (real-time) indicators. Together we can take all three types of indicators into account to help provide context for what can often seem counterintuitive behavior, especially in the face of intense global disruption.
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1. Investopedia.com, April 18, 2020
2. TheNatureOfMarkets.com, 2020
3. CNBC.com, April 6, 2020
4. USNews.com, March 11, 2020