As of this writing, the stock market continues the slide it began last week with the largest drop since the Great Recession. Positive economic news abounds, so what gives?
Don't let the President's comments mislead you: the stock market is not the economy. To the contrary, I've argued that at times a high stock market results from a weak overall economy. The Obama Administration illustrated very well this dichotomy: The Dow was just under 8000 points when Obama took office, and when Trump took office, it was nearly 19,900. Over an 8 year period, that's a return of over 12% per year for 8 years in a row. Yet, the real economy-- the American GDP-- grew at a much lower 3.8% nominal value. And that's NOMINAL, so that reflects the typical 1.5%-2% inflation as well. Thus, real economic growth was likely only about 2% per year (on average).
Other contradictions between the real economy and the stock market are readily observed. For example, rising interest rates usually point to improving economic conditions as the economy makes its own money and creates inflationary pressure. Rising home prices, rising fuel prices, etc are evidence of rising demand, increasing spending, and a generally more optimistic view of the economy.
Yet we know that Wall St responds very negatively to a rise in interest rates. Indeed, it's likely that this negative response explains much of the recent tumble in the markets; they are afraid that the Fed will raise interest rates.
Why do they care so much about rising interest rates, even when it means the overall economy is improving?
Recall with me that all loans are denominated in nominal dollars. Inflation reduces the value of those dollars over time. So lenders charge an interest rate partially to protect against that loss of value from inflation. But what happens if the actual interest rates go far above what was used to secure a debt instrument? The lender can actually lose buying power. If I borrow money at 2% interest and inflation goes up to 4%, the lender is actually losing money through inflation.
The vast majority of Wall St profits have to do with finance, and Wall St banks are on the lending side of the transaction. So what harms them is a windfall to the borrower and vice versa.
Meanwhile, main street businesses in your locality benefit from increasing consumer confidence and the spending boom that is driving higher interest rates.
The upshot here: not only is our economy much more than just Wall St., there are times when a declining stock market can be evidence of real economic growth, just as there are times when a high stock market is driven by a stagnant economy that has nowhere else in which to place investment capital.