Are the Stock Market and Economy Related?

As soon as the United States took a hit from the COVID-19 pandemic, so did the economy on a macro level. Businesses were, well, losing business, so unemployment was higher than ever. International travel and trade sank, causing gross domestic product (GDP) and inflation to take a dive. After experiencing these catastrophes, the Federal Reserve not only abundantly increased federal stimulus to businesses and individuals but also decreased interest rates, and thereby, the 10-year treasury yield. 

At that same time, the S&P 500, a major index of the stock market, was giving investors a scare with a 9.5% drop on March 12, 2020, and an 11% drop 4 days after that. However, that was the worst of it as the low rates, stimulus pouring in and bond buying largely helped the stock market recover back to pre-pandemic levels in August 2021.

The relationship between the stock market and the economy is complex and multifaceted, often defying straightforward explanations. While there is a correlation between the two, it is not always consistent, and they can sometimes move independently of each other. Here are some key points to consider:

1. Loose Correlation: Historically, the stock market and the economy tend to move in the same direction, but this correlation is not always precise or immediate. For example, during economic expansions, stock prices often rise, reflecting optimism about corporate profits. Conversely, during recessions, stock prices may decline as earnings outlooks dim.
2. Divergence: There are instances when the stock market and the economy diverge. Market sentiment, investor behavior, and other factors can lead to stock market fluctuations that do not necessarily reflect the underlying economic conditions. This can occur due to factors such as speculation, investor sentiment, and market manipulation.
3. Leading vs. Lagging Indicator: Some argue that the stock market acts as a leading indicator for the economy, meaning it anticipates future economic trends. Others believe it is a lagging indicator, reflecting past economic performance. The debate continues among economists and market analysts.
4. Psychological Factors: Investor sentiment and confidence play significant roles in driving stock market movements. Positive news or sentiment can lead to bullish market behavior, while negative news can trigger sell-offs, regardless of the underlying economic fundamentals.
5. Long-Term Trends: Over the long term, there is a general alignment between stock market performance and economic growth. However, short-term fluctuations and market dynamics can create temporary disparities.

While there is a relationship between the stock market and the economy, it is nuanced and subject to various factors. Investors should consider a range of economic indicators, market fundamentals, and psychological factors when analyzing market trends and making investment decisions.

• Average total annual S&P 500 earnings over the past 50 years: $66.94
• Number of years with above average total annual S&P 500 earnings: 19 years
• Number of years with below average total annual S&P 500 earnings: 33 years
• Average % change in earnings per year over past 50 years: 8.27%

• Average 10-year treasury yield over the past 50 years: 6.13%
• Number of years with above average 10-year treasury: 27 years
• Number of years with below average 10-year treasury: 25 years
• Average % change in yield rate per year over past 50 years: -1.22%

• Average inflation rate over the past 50 years: 3.97%
• Number of years with above average inflation rate: 18 years
• Number of years with below average inflation rate: 34 years
• Average % change in inflation rate per year over past 50 years: 15.41%

• Average S&P 500 annual return rate over the past 50 years: 12.23%
• Number of years with above average return rate: 29 years
• Number of years with below average return rate: 23 years
• Average % change in return rate per year over past 50 years: 18.00%

Diving Deeper: Correlations (or Lack of) Between Market and Economy

• 19 years with above average annual S&P 500 total earnings and below average 10-year yield
• 27 years with below average annual S&P 500 total earnings and above average 10-year yield
• 13 years with above average annual S&P 500 return and below average 10-year yield
• 11 years with below average annual S&P 500 return and above average 10-year yield

• 18 years with above average annual S&P 500 total earnings and below average annual inflation rate
• 17 years with below average annual S&P 500 total earnings and above average annual inflation rate
• 20 years with above average annual S&P 500 return and below average annual inflation rate
• 8 years with below average annual S&P 500 return and above average annual inflation rate

• 17 years with above average annual inflation rate and above average 10-year yield 
• 24 years with below average annual inflation rate and below average 10-year yield

• 11 years with above average annual S&P 500 total earnings and above average annual S&P 500 return
• 18 years with below average annual S&P 500 total earnings and above average annual S&P 500 return
• 15 years with below average annual S&P 500 total earnings and below average annual S&P 500 return

Notable years with the highest and lowest number for each statistic and category:

• Highest and lowest inflation, respectively: 13.55% (1980), -0.36% (2009)
• Highest annual change in inflation: 950% (2016)
• Highest and lowest 10YR Treasury yield: 13.92% (1981), 0.89% (2020)
• Highest annual change in 10YR Treasury yield: 62.92% (2021)
• Highest and lowest S&P 500 total earnings: 147.46 (2019), 19.23 (2008)
• Highest annual change in S&P 500 total earnings: 233.49% (2009)
• Highest and lowest S&P 500 annual return: 38.46% (1975), -37.22% (2008)
• Highest annual change in S&P 500 annual return: 3,094.96% (1995)

Methodology:

To analyze a possible correlation between the S&P 500 and the economy, we examined the returns and earnings of the S&P 500 and various macroeconomic indicators over the past 50 years and analyzed relationships and trends.