The recent stock market highs during the past few months have many folks confused.
“How is it,” they ask, “that stocks are performing well, while the economy falters?” This is a good question that merits an answer.
The Wall Street numbers that we hear on the news are an index of the minute-to-minute assessment of buyers and sellers, half of whom think prices are too high while the other half think them too low.
Almost all the news analysis as to the whys and wherefores of the stock market indices are piffle. The best prediction of stock prices today is yesterday’s price and one of the day-to-day changes of the past chosen at random.
The only information content that can be gleaned from stock prices is the expectation of short-run profitability of businesses traded on the exchange.
What, then, do short-run profits say about the overall economy? Not too much, as it turns out, and certainly nothing consistent. Stock prices depend on profits, and in the short-run, profits are determined by lots of things. Consumer buying power, government buying power, international trade, and Federal Reserve and government policy actions all affect profits.
In 2008, the stock markets corrected dramatically in response to fears of an impending financial market collapse. This made sense because a well-functioning financial system is necessary for profitability.
Government intervened with stimulus spending, and the Federal Reserve boosted the money supply, reducing interest rates in a bid to stabilize the economy. This calmed the profit fears, and the stock market recovered a bit. Since 2009, we have seen a slow and painful climb back to higher stock prices.
Today we are likely in a recession; taxes have just increased, and government spending looks to get a big cut in a few weeks.
Eight million more folks are looking for work than in 2007, and consumers are not buying like they were in those pre-recession salad days. Still, stocks thrive. How can that be?
Demand for goods is indeed dampened in the wake of the recession. So too are the costs of production. Profits are a function of both revenues and costs, and so a leaner, more productive business can be highly profitable even when the overall economy languishes.
Even with the negative growth in the fourth quarter, the U.S. produced more goods and services in 2012 than in any year in history. We are just doing so with far fewer workers.
This shedding of 8 million unneeded workers boosted profits for lots of businesses, but there is more to the story of stock prices than this.
Our Federal Reserve and government policy makers rightly laud higher stock prices. But labor markets, not stocks, focus policy action. A weak economy means more stimulus, and more stimulus means more short-run profits.
So, for Wall Street we have the best of all worlds, and so stocks rise. Not so for Main Street, and the millions of workers who have been passed by in this recovery.
Michael J. Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University.