The stock market and the economy are often thought of as being closely linked, but the reality is that the relationship between the two is more complex. The stock market is forward-looking, reflecting expectations about how a company will perform in the future, whereas most economic data looks back at what has already occurred. As a result, economic news can occasionally seem contradictory. It can be good or bad, but what really matters is whether it is better or worse than investors expected.
For example, if economic news comes out that is better than expected, stock prices may increase; investors become optimistic about the future performance of companies and are willing to pay a higher price for stocks. Conversely, if economic news comes out that is worse than expected, stock prices may decrease; investors become pessimistic about the future performance of companies and are willing to sell their stocks.
The Citi Economic Surprise Index measures whether incoming economic data surprises to the upside or the downside. Currently, it is near its highest reading for the year[1], indicating that recent data has been better than expected. This helps explain at least some of the strong rally in the S&P 500, despite calls from many for an economic recession. In addition to the strong rally in the S&P 500, we have witnessed a decrease in volatility. The VIX also known as the fear index, measures the expected volatility on the S&P 500. It has been steadily declining throughout 2023 and has actually reached its lowest level since before the pandemic[2]. This is something that may come as a surprise given negative earnings in the first quarter and provides a clearer understanding of how “better or worse” matters more than “good or bad.”
The dynamic relationship between the stock market and the economy is crucial for investors. By understanding this relationship, investors can better interpret economic news and make more informed investment decisions. By creating custom financial plans that act as your blueprint, we can help you navigate various market conditions while optimizing your investment strategies.
[1] Source: FactSet. Date: July 4, 2023
[2] Source: FactSet. Date: July 5, 2023
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