Stock Market vs Economy | Erik Averill, Brandon Averill | AWM Insights #11
Episode Notes
In recent weeks, we've seen a lot about how the stock market seems to be rallying, but the economy is doing poorly. As a result, we've received a lot of questions about how there can be a disconnect between those two entities.
However, when the stock market is mentioned, many refer to the S&P 500, which only makes up only 44% of the U.S. economy. Whereas, when we discuss the actual economy, it encompasses all goods and services being produced. Likewise, stock market data is a prediction of how those companies might do in the future, whereas economic data is data about the past. How can you navigate all this information? And how does it connect together?
In this week's episode, Brandon and Erik address these questions and cover:
A definition of both the stock market and the economy
The information and data available about each one
What - if any - information can be utilized between one to inform decisions about the other
The distinctions between the two including how one can be doing well while the other suffers
+ Read the Transcript
Erik Averill (00:00):
Hey everyone, welcome back to another episode of AWM Insights. I am your host, Erik Averill, alongside my cohost, Brandon Averill. Brandon, we want to jump right into it today. One of the things that we've been talking a lot about internally and just questions we've been asked about our client base is, we have seen this correction of the stock market, yet a lot of the news coming out about the economy is negative, and there's just this disconnect between the performance of both of them. The question really is, is why can the economy be doing so poorly, yet the stock market is rebounding and continues to, almost not taking notice of what the economic news is saying. Brandon, that's where I want to start is just asking, why is there a disconnect between the stock market and the economy?
Brandon Averill (00:52):
Yeah, Erik, I think it's a great question. It's a question we're getting pretty often, and I think a good place to start might be defining what is the economy and then what is the stock market. The definition for economy, this is the production and consumption of all goods and services. This is going to encompass all individuals, all companies, and the government as well. It's the total production, whereas the stock market is a little bit different. What the stock market is, I think people think that it's this mythical thing. Right? That you can invest in this, quote unquote, thing called stock market. But, just a reminder that the stock market is actually just an exchange where there's buying and selling, and then new shares being issued for publicly held companies. This could be domestically in the United States, it could be internationally. The market, when people refer to the market, it's usually a geographic base, but it's a place where you actually go and buy and sell the ownership of companies.
Brandon Averill (01:52):
When we talk about investing in the stock market, we're going, we're putting together a basket, right, and buying ownership in specific companies. I think that's really kind of a big disconnect, is people don't realize that the stock market only really represents about 40% of the companies in the US, whereas the economy is going to bring in data from all 100% of those companies. Then, just to further clarify a little bit, I think the other big distinction here is that the economy, when we talk about it, economic data, it's all reporting in the past. What we're doing is, we're taking all this information and seeing what's happened in the past. Whereas, the stock market is very forward looking, and so it's trying to predict what's going to happen in the future. Again, it's only trying to predict what's going to happen in the future with approximately 40% of the companies in the US. There's some pretty big distinctions on why they don't move together or react together. It's because they're pretty two distinct different things.
Erik Averill (02:58):
One of the things that I thought that you said was super interesting, it's so easy to pass over. A lot of times when we talk about the market, right, is we distill that down to just the S&P 500, the 500 largest companies in the United States. But, there was this crazy stat that you started to reference, that small businesses, which is defined as businesses with less than 500 employees, that it actually makes up 44% of the US economy, and those are private companies, meaning you cannot go access and invest in those companies on the public stock market. Here's the staggering thing. Those small businesses, they make up a whopping 99.7% of the employment in the United States, so two-thirds of the net new jobs come from small private businesses.
Erik Averill (03:54):
I just think it's really interesting and it starts to make more sense of going, we see what's happening, maybe just off of this proxy of 500 companies, and we think that that represents the entire United States. You can start to see this disconnect. One question I do have, Brandon, is, is you do hear people on the investment world start to talk about trying to use economic information to predict markets. To say, "Okay, right now we know that COVID is going to end at some point and things will return to normalcy in 2021. The economy will get better." Should we try and predict into the future and use economic information to make our investments? How does that come into play for us?
Brandon Averill (04:42):
Yeah, I think if you really look at the data, and there's definitely two schools of thought here, but we always turn back to the academic data and it supports that that's very difficult and nearly impossible to do, is to take a look at past information and try to predict the future. Again, I keep going back to this. It's, that's the concept of believing that you have some ability to predict the future based upon very recent information from the economy, and for us, that's just extremely difficult to do. We were fortunate enough, had a client shoot us an article this week that I think clarified that, and just showed really a study of the last couple months and how difficult that could be.
Brandon Averill (05:25):
I mean, we had the huge correction back in March and things looked grim. We started seeing unemployment numbers plunge. We started seeing concerns around a second wave, or really that was still the beginning of the first wave. No idea what was happening, but we saw economic data being negative. At that point, if you looked at it and said, "Hey, this is terrible. I'm going to trade on this. I'm going to predict the future and say, hey, this is going to get worse," you would have sold out, and then what we saw that April brought to was the best month since 1987 in the US in the S&P 500. You would have totally missed that entire run-up, and I think we all know from previous talks that missing even just the few best days in the market completely impact your return. I think that's a great example of seeing, hey, we know that things haven't been great because we're getting all the economic data, but to turn that into a prediction about the future is just very, very difficult to do.
Erik Averill (06:28):
That's super helpful and I'm just reminded of the previous podcasts and the advice that we offer on a regular basis is, this is really about staying disciplined. This is about controlling the controllables. Right? Your expenses, your taxes, your diversification, and the emotion of an investor, we want to try and be able to predict things, but when you really start to review who is rewarded, it's longterm investors who stay in the game. One of the articles of a great blog that I encourage everybody to read, it's called A Wealth of Common Sense.
Erik Averill (07:06):
The other factor that a lot of people don't talk about is one of the best ways to make up these performance things is through dollar cost averaging. Right? It's continuing to add money to your investments time and time again, over the longterm. While nobody can predict the future, we can look back over the last hundred years of performance of publicly traded companies and say, hey, if you have a large exposure to ownership, you are going to be rewarded for the risk that you can take. Brandon, just kind of final thoughts about, where does the economy come into paying attention to it as a longterm investor? Is it something that we can completely ignore, or does it actually have an impact on longterm returns? It's just a question we've had a lot about with people printing money, and can I reliably think that the future returns are going to be the historical 10%, or does the economy not have any impact on longterm returns?
Brandon Averill (08:13):
That's a great point, Erik. I mean, the economy, like you mention, we're going through, there's many other factors at play right now. I mean, we've got massive stimulus going on, record low interest rates, and then, like you said, I mean, we've got the economic data that's coming out that's backward looking. I think it would be foolish to say that the economic factors wouldn't have an effect on longterm performance. I think that's absolutely the case. I think there is a case being made that, as we bring future returns in via economic stimulus or whatever actions are probably being taken, there is a high likelihood that returns going forward aren't going to be expected to be as high as they have been in recent history.
Brandon Averill (08:57):
However, I think the big point here is that, while that may be true, what the academic evidence also supports is that we can't predict that. What we're believers in is that capital markets work. All the prices, the fact that there are people out there buying shares in companies means that the expected return going forward is positive, and so we want to continue to be invested. We know that growth in investments will come over time. What that number is, is a little bit more difficult to figure out, but we're going to continue to rely on the academic evidence and we're going to continue to help clients stay invested because we know that's what builds wealth over time.
Erik Averill (09:35):
That's a great summary. Just for all the audience listening, I think one of the resounding things that comes through is, this is about having a longterm plan. It's about you meeting with your certified private wealth advisor to make sure that whatever decisions you are making, whether it's investing in the public stock market, whether it's trying to get exposure to higher expected returns in the private markets, that this is all about having a disciplined plan for the longterm to help you meet your goals, so highly encouraged to make sure that you guys have at least had that conversation checking in with your certified private wealth advisor. Until then, as always as we sign off, we really appreciate your guys's attention. We would love to hear from you, any topics that you want us to cover. This really is all about you guys. We believe that the more educated we are, the better investment decisions that we'll make. Until next time, stay humble, stay hungry, and be a pro.
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