Why stock market doesn’t reflect the economy

Why stock market doesn’t reflect the economy

Wall Street has traditionally recovered before Main Street rights itself

By Rachel Beck

updated 4:54 p.m. ET Oct. 21, 2008
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NEW YORK – The stock market is not the economy.

The market’s painful slide downward may be ending. The economy’s suffering has a long way to go.

How do we know that? Washington is telling us. It’s saying the economy is still in serious trouble and opening the possibility of another government-funded stimulus package.

“With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate,” Federal Reserve Chairman Ben Bernanke told Congress on Monday.

The financial world has been buzzing over whether the all-out panic that fueled the recent stock rout could really be over.

On Oct. 10, the Dow Jones industrial average plunged to a close of 8,451.19 — its lowest in 5 1/2 years. Then it spent most of last week seesawing, but finished with its best weekly performance in five years.

Investors are feeling like we might have reached a turning point. They point to improving credit conditions. The London interbank offered rate, or Libor, has retreated from recent highs, which means lower interest rates on consumer loans like adjustable-rate mortgages.

There is also evidence that the market had faced extreme conditions that couldn’t last. For instance, a closely watched “fear gauge” — the Chicago Board Options Exchange Volatility Index, which is known as the VIX — topped a record high of 80 last week, well above its typical level that runs closer to 50.

None of this means the economy is poised to begin healing, though. Historically, the stock market has turned a corner months before recessions end.

In the 21 recessions from the start of the 20th century, the average economic decline lasted 14.4 months and the Dow industrials tended to bottom out just over 8 months into that, according to Bespoke Investment Group.

The situation is more troubling when you break out the 10 recessions that took place before World War II, which economists say better reflects the severity of today’s economic woes. Those lasted 19.1 months on average, and the Dow bottomed a year after they started.

A recession hasn’t even been formally declared in the United States yet, at least when using the typical gauge of two or more quarters of negative economic growth. But most economists agree that conditions have turned so weak there is a great likelihood that we are already there.

Dean Baker of the Center for Economic and Policy Research, a Washington, D.C. think tank, points out that higher or lower stock prices aren’t what drive companies’ investment decisions or their hiring plans. Those decisions are made based on economic conditions and what is happening in specific markets.

“The market may be OK,” Baker said, “but we are still facing a tough recession.”

A big hurdle: The continuing collapse in the real-estate market, where some $5 trillion of housing wealth has been lost in the last few years. Even if stock prices surge, consumers will remain leery about spending if they don’t see some bounce in home prices. That hits the economy hard because two-thirds of its growth comes from consumer spending.

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If people don’t spend, companies will have to cut jobs. The nation’s unemployment rate — now at 6.1 percent — could hit 7.5 percent or higher by next year, according to some economists’ predictions.

That’s why momentum is building in Washington for another economic stimulus package to help cash-strapped Americans.

Earlier this year, most individuals and couples received tax rebate checks of $600-$1,200 through the $168 billion stimulus package enacted in February. The government also passed earlier this month a $700 billion rescue plan for the financial system.

President Bush and Bernanke said Monday they were open to the idea of a new stimulus program.

Whatever they ultimately do will take time — something the economy is running short of.

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