Is the Stock Market Disconnected From the Economy?

Is the stock market disconnected from the economy? Perhaps, but less so lately. Also, looking under the hood of performance trends over the past year reveals a more nuanced relationship.

Before getting to the many unique characteristics of the COVID-19 cycle, an important reminder to investors is that stocks tend to lead the economy. In fact, the S&P 500® index is one of the 10 components of The Conference Board’s Leading Economic Index (LEI). The LEI is only 1.5% below its prior peak from July 2019 and has erased nearly 90% of its pandemic-related decline. Since last April, the LEI has surged nearly 14%, which is only the second time since 1959 that the nine-month rate of change exceeded 10%.

Because stocks tend to lead the economy, it’s typically the case that at major stock market inflection points, the economic data is typically lagging. In other words, market peaks have generally preceded recessions’ starts, and market troughs have generally preceded economic recoveries’ starts.

As the table below shows, in the post-WWII era, there was only one exception to bear markets starting and ending before recessions started and ended, respectively. Although the 2000-2002 bear market started before the 2001 recession began, the bear market continued for another 11 months after the short/mild 2001 recession had ended.

Bear markets have tended to start and end before recessions have started and ended

Source: Charles Schwab, Bloomberg, National Bureau of Economic Research. A bear market is defined as a 20% or greater drop in the S&P 500. Recession start and end dates are as determined by the National Bureau of Economic Research (NBER) Business Cycle Dating Committee. Past performance is no guarantee of future results.