Why Stock Mkt has diverged from Economy - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 9 March 2013
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- By Asad Dossani, Author, The Lucrative Derivative Report


Asad Dossani
Earlier this week, the US stock market made headlines for reaching its highest level ever. The Dow Jones finally recovered all of its losses since the start of the financial crisis. It has been a long road to get to this point, but this is significant nonetheless.

The Indian stock markets are not far from their all time highs too. The Nifty index made highs around 6,300 and currently trades at around 5,950. This is after having lows around 2,500 a few years ago. The same story is true around the world. Global markets have recovered most of their previous losses.

Though stock markets have recovered, economies have not. Nearly every country has economic indicators significantly worse than what they were in 2007. Unemployment is higher, GDP growth is lower, and the population is generally worse off. It isn't all doom and gloom as there has been some recovery in most economies, but they certainly aren't back to their prior levels.

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Why is this the case? How is it that the stock market has recovered all its losses, but the rest of the economy is still suffering? What is important to understand is that the stock market doesn't fully represent what is going in the economy. The stock market is effectively determined by two factors.

Firstly, the stock market is determined by the performance of the companies in the market. Markets have done well because corporate profits are high. High profits don't necessarily translate into more employment if companies do not invest as much, which is what is happening now.

Second, the market is determined by interest rates. Low interest rates mean more incentive to invest in stocks, lower discount rates for corporate earnings, and more cash in the system to enter the markets. Interest rates are much lower today than they were in 2007, and this accounts for some of the rise in the stock market.

Thus, it is clear why there has been such a divergence between the performance of the stock market and the overall economy. Still, the rising stock markets are a good sign. They could be a precursor of things to come, and we could certainly see a marked improvement in economic outcomes in the medium term.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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5 Responses to "Why Stock Mkt has diverged from Economy"

Sujay Sahu

Mar 15, 2013

Superficial analysis. Demand slowdown is a given mainly due to ageing western polulation and deep debts. US multinationals profitability is up due to earnings from developing countries. Markets will take a big hit sometime in 2013/2014. Inflationary pressures are here to stay. India's markets are even more vulnerable than USA.

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natraj

Mar 12, 2013

infactual and superficial analysis.

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Chandrasekaran

Mar 12, 2013

Using stock market for measuring real economical growth may lead to great confusion because of its selfish & greed in nature, every one wants to make some money & keep their monitory position safe & secured for their future.So this kind yard stick may lead to inflated idea on any economical conclusion.

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Krishna

Mar 10, 2013

The theory about corporate profits is hard to digest. When things are tough competition should eat profit margins. What could be happening is innovative accounting to show profits for current year at the cost of risking lower profits in future or factoring hope that there may be recovery in the future.CEOs these days live quarter to quarter .

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Sharmila Rao

Mar 9, 2013

I thought the corporate profits have dropped in the latest Quarter...

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