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Are ‘the economy’ and ‘the market’ synonymous?

It’s all semantics. Or is it? Larry Swedroe explains the relationship between these often interchanged terms in an effort to help us make sense of the financial headlines we hear and see in the news.

Transcript

Tim Maurer:
Hello and thank you for tuning in to Ask Buckingham, an ongoing video podcast series where we invite thought leaders across many disciplines in wealth management to respond to the questions on your mind. My name is Tim Maurer and I have the privilege of hosting these short discussions as the director of advisor development for Buckingham Wealth Partners. Today we’ll be hearing from Larry Swedroe, Buckingham’s chief research officer, and here’s the question we’ll be tackling.

Tim Maurer:
Larry, I see a ton of commentary about the economy and the market. These words, economy and market, seem to be used as though they’re synonymous, are they? And if not, how are they different?

Larry Swedroe:
That’s a great question, Tim. It’s one of the ones I get most frequently. The answer is clearly they’re related of course, but the market is what is called the leading indicator. It tends to move ahead of the economic news.

Larry Swedroe:
One of the things we know is when the market goes down, the economy tends to go down later, but there are lots of false signals. It’s nowhere near a perfect indicator. Let me give two examples that I think will be helpful. In the fourth quarter of 2018 the market crashed because it was fearing this tightening by the Federal Reserve, which was the right thing to do probably at the time because the economy was recovering, but the market reacted negatively. Nothing happened to the economy. In fact, the economy was doing quite well. Unemployment continued to fall. That’s one example.

Larry Swedroe:
Another I can think of, we had a major crisis. It was called the Asian Contagion in ’97, ’98. It started there. We had a currency crisis in the far east and we had a major hedge fund longterm capital blow up and that was going to destroy the whole banking system. From June through I think early September, the stock market dropped 25%. Now I’m sure most of our listeners don’t recall that at all. The economy kept roaring along and there’s another example of that situation, plus the crisis resolved itself quickly and there was no economic impact.

Larry Swedroe:
Here, the right way to think about it is the economy is now going to be impacted, but the market went down ahead of that and just as likely the market will begin to recover well before, six to nine months is typical. Sometimes it’s even more than that ahead of the economy recovering. That’s why it’s so important to really ignore the economic news because by the time you read it, it’s already in stock prices. Let me add last thing.

Tim Maurer:
Sure.

Larry Swedroe:
From ’08 on, we had that horrible financial crisis. The worst recession we had since the great depression ended on March 9th of 2009. The next eight years were the worst recovery we ever experienced in the post war era. It was the only time we went, any president two terms, went without one single year a 3% growth.

Tim Maurer:
Wow.

Larry Swedroe:
I asked our listeners to think about if you knew that was going to happen, this will be the slowest recovery we ever had. How do you think stock prices do? Do you think you want to be in stocks? I think most people would say, “Boy, they would be pretty bad investments.” And yet, we had one of the greatest recoveries in stocks in history. There’s a great example about stocks and the market and the economy can really diverge and so, history teaches lessons we need to be aware of.

Tim Maurer:
Yeah. Well, so thanks for making us aware of that lesson. And then how do you think as individuals and investors, Larry, how can we begin to apply this divergence and relation between the economy and the market?

Larry Swedroe:
Yeah. The best thing I could tell you is ignore the economic news because it’s only likely to cause you to act when doing nothing, which means sticking to your plan, which anticipated that we would have periods just like this. We just don’t know what will be the cause of the next crisis. If you follow the economic news, it’ll likely rattle your stomach. And I’ve yet to meet a stomach that makes good decisions. Heads make much better decisions than stomachs, but even heads can make bad decisions if you don’t think things through ahead of time, we can get rattled. We get scared and then we make bad decisions because our own immune system reacts and we try to, this flight or fight mechanism when we try to flee from whatever is causing the fear. That leads to panic selling, which is what is probably contributing to this drop currently in the market.

Tim Maurer:
We’re certainly seeing something like that Larry. Well, thank you so much for sharing your wisdom and thank you for tuning in to this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com or emailing your question to question@askbuckingham.com or just click on the link you see here in the screen.

Tim Maurer:
Remember, there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, you’ll be able to apply that knowledge
in pursuit of good decision making. So please follow us. And by all means, Ask Buckingham.

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