While many investors have avoided stocks in recent years because of economic concerns, Charles Schwab Chief Investment Strategist Liz Ann Sonders says history shows that to be a bad idea.
“The connection between the stock market and the economy seems obvious,” Sonders writes in commentary on Schwab’s site. “If the latter is performing well, the former should follow. In reality, not only is the opposite typically true — stocks lead the economy — but the two can often appear to be completely disconnected.”
Rather than being “glued at the hip, as many investors assume,” Sonders says the market and economy are “more like … tethered at the hip by a fairly long rope. Ultimately they can’t get too far apart, but the two can move in different directions — and at different paces — in the shorter term. The trick for investors is to understand the relationship and know how to avoid some common mistakes.”
“The bottom line,” Sonders says, “is that the stock market, as a leading indicator, tends to launch into rallies and/or corrections around economic inflection points. By definition, a rally-inducing inflection point occurs when economic growth stops falling and begins to rise, which means GDP growth is at its worst. This is part of why new bull markets can breed rampant skepticism.”
Sonders also says that earnings and the stock market can diverge significantly in the short term. And she looks at other factors that impact stock prices, including valuation, economic surprises, and the Federal Reserve.