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A funny thing happened on the way to the 2024 election. Well, actually, a lot of interesting things happened. (Ron DeSantis!) But I’m talking about the economy. As I wrote in my latest column, consumer sentiment is rapidly improving, and it appears that the economy is finally catching up with the reality that the unemployment rate is low and the inflation rate is declining.
It means suddenly. This is a graph from a Michigan study that is the most widely cited measure of consumer sentiment.
OK, this is just one study and some of what we’re seeing may be statistical noise. Other surveys have also shown improvements in perceptions of the economy, but not as sudden a break. Still, it’s interesting to ask what led to the surge in Americans’ sentiment about the economy. And one obvious candidate is a rising stock market.
In fact, there’s good reason to believe that stock prices influence perceptions of the economy. What is less clear is why. So let’s take an emotional view of the stock market. In other words, let’s look at the relationship between the stock market and consumer sentiment. (No, I don’t have warm and fuzzy feelings about the Dow.)
The evidence that stock markets influence consumer sentiment is based in part on average statistical relationships. For example, see this 1999 analysis of the Federal Reserve. It is also based on some notable examples. This is my favorite example, consumer sentiment from 1987 to 1988.
Why did consumer sentiment slump for several months in the fall of 1987 and then recover? There were no significant changes in the real economy, and there were no significant changes in unemployment, inflation, or economic growth. What actually happened was Black Monday, October 19, 1987, when the Dow suddenly fell 22.6% for no apparent reason.
Should consumers care when the stock market fluctuates? Probably most people shouldn’t.
While it’s true that only a minority of Americans own stocks directly, the majority have some exposure to the market when considering indirect holdings, especially retirement plans. However, even when including these indirect investments, most people’s stake in the market is small. According to the Federal Reserve, in 2022, the average American household directly or indirectly owned nearly $500,000 worth of stocks. However, these assets were concentrated among the highest income 10 percent of the population. The median household owned just $52,000.
So most Americans don’t need to worry too much about what happens to stock prices, at least in terms of the direct fiscal impact.
In any case, doesn’t the stock market predict the future of the entire economy? No, in 1966 the great economist Paul Samuelson quipped that the stock market had predicted nine of the past five recessions. Subsequent experience confirmed his skepticism. The 1987 crash was not a harbinger of a recession. The 1998 bear market was no different.
Why is the stock market so bad at predicting recessions? There are at least three reasons that come to mind.
First, no one is good at predicting recessions. This fact is beautifully proven by the failure of all 2022 recession predictions. Stock traders may have special insight into a particular company (or its inside information), but when it comes to the economy as a whole, they have the same problems as all forecasters. I mean, it’s very difficult to call it a tipping point.
Second, stock prices are probably more influenced than most other asset prices by human psychology: hope, fear, and greed. As a result, stock prices often rise or fall sharply for no particular reason.
Finally, it’s not even clear that the prospect of a recession will lead to lower stock prices. Indeed, a recession leads to lower profits, which, other things being equal, should have a negative impact on stock prices. But the Fed typically responds to economic downturns by cutting interest rates, and all else being equal, lower rates should support stock prices. Which effect will predominate? It’s not clear.
Incidentally, this last point suggests that the bond market, which primarily reflects expectations about future Fed policy, should be a better guide to the future of the economy. Also, bonds are not as sexy as stocks, so bond trading probably makes more sense. Historically, there was an inverted yield curve, meaning short-term interest rates exceeded long-term interest rates. have It has become a useful indicator for predicting economic recession. But not this time, at least not so far.
Regardless, the point is that ordinary Americans shouldn’t judge the economy by looking at the stock market. But many of them clearly do. why?
One answer is that while the stock market may be a poor indicator of the state of the economy, it is highly visible. Unlike other economic data, the latest movements in stock prices are always displayed on your TV or smartphone. Therefore, in a sense, it is natural for people to judge the economy by the numbers they see all the time.
Another answer is that news coverage of the economy can be strongly influenced by stock prices, even if it is not inherently so. After all, stock price movements are an easy trap for reporting. I would venture to say that, on average, news industry executives arguably have a much larger stake in the stock market than the median American.
Sure enough, the San Francisco Fed’s News Sentiment Index, which tracks the tone of news coverage rather than the mood of consumers, rose sharply at the start of the current rally.
So what should we make of rising consumer sentiment? On the one hand, it makes a lot of sense given the economic realities of low unemployment and low inflation. On the other hand, the timing may have been driven by financial indicators that most Americans should really ignore.
I have no choice.
quick hit
Jordan Wiseman has similar thoughts.
When the coronavirus struck, Donald Trump sent his supporters a signed chart showing rising stock prices on their watches.
Stock prices gave no warning of the 2008 crisis.
“Sentiment is currently just 7% below its historical average.”
face the music
he is your man
when Stocks are expensive
However, be careful once you start descending
At that time, those lice
return to spouse
Diamonds are a girl’s best friend
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