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Disconnect Between the Markets the Economy

Disconnect Between the Markets the Economy

| August 31, 2023

Trying to reconcile recent market advances with not-so-good economic data

U.S. stock markets continue to trend up as optimism returns to Wall Street while Main Street USA continues to struggle. For sure there is plenty of social unrest around the country, geopolitical tensions with China, Russia and North Korea are increasing and some not-so-great negative economic data continues to be released almost daily – but the major U.S. markets are trading close to all-time highs.

In fact, as of late July 2023, the DJIA and S&P 500 are within earshot of their all-time highs and NASDAQ is not too far behind its peak as well.

The Markets Have Covered a Lot of Ground

If you go back to the fall of 2022, many market pundits were suggesting that maybe fundamental conditions were supportive of a favorable environment for stock markets in 2023. Unemployment was trending down, there seemed to be consensus when the Fed might stop raising rates, corporate earnings were decent and gross domestic product (GDP) growth was solid at 2.6% in Q4.

Fast forward to the end of the second quarter of 2023 and everything popped – at least as it relates to the stock markets. Through the end of the second quarter:

  • The S&P 500 was up more than 16% YTD and had turned in its best first half since 2019;
  • NASDAQ was up an astonishing 31%+ YTD on its way to its best half since 1983; and
  • The DJIA had turned in a still-decent 3.9% YTD gain.

In other words, the markets covered quite a bit of ground in a very short period of time.

But that’s not the whole picture. And the recent rally begs the question, did the markets move too far and too fast?

The Markets Look Forward, Not Backward

It can be challenging to reconcile why stock markets could conceivably perform well amidst a constant drip of negative economic news. Intuitively, it just doesn’t make sense. But, the apparent disconnect between markets and the economy is actually normal.

This is because the economic data we receive every week is backwards looking. It tells us what happened. The Employment Situation Report, for example, reports the previous week’s unemployment numbers. Most of the other monthly economic data, by comparison, captures what happened in the previous month – with some data reports going back two or three months.

The stock markets, on the other hand, are forward-looking. In other words, the recent rally in the first half of 2023 was more about the markets (i.e., investors) feeling more positive about the future versus uncertain about the present. Whereas the economic data received during this rally was actually showing signs of stress.

How forward does the market look? Well the answer to that depends on who you ask. But generally speaking, the markets look forward at least a couple of quarters, maybe even as much as 18 months.

Does That Mean It’s Over?

Well, we might like to think that we will see nothing but sunny skies and smooth sailing going forward, but that’s not going to happen. Especially when you consider that the recent market rally was really over a very short-term period.

That being said, the recent market rally is encouraging. In fact, often times, strong rallies occur in the beginning stages of a new bull market and maybe we can look back five years from now and recognize that this was the case for our recent rally. Or maybe not.

What Should Investors Do?

The U.S. stock markets can and do move faster than the U.S. economy, but longer-term, the two are absolutely connected. And while there are reasons to be optimistic, there are also plenty of reasons to worry too. As such, it’s important for investors to manage their expectations appropriately.

Further, investors should work towards appropriate diversification, given their tolerance for risk. This includes periodic rebalancing – not short-term trading – to help the original asset allocation that was deemed appropriate remain intact. 



Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risks including possible loss of principal.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

Asset allocation does not ensure a profit or protect against a loss.

Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

The NASDAQ-100 is composed of the 100 largest domestic and international non-financial securities listed on The Nasdaq Stock Market. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology, but does not contain securities of financial companies.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by RSW Publishing.

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