Can Stocks Rise in a Horrible Economy?…..You Bet!
The economy gets worse yet the market hardly budges. What gives? We’re taught that a bad economy has to be bad for stocks. However, most of us fail to look under the hood, and in this case ask two simple questions:
Question #1: Is the economy bad?
Answer: Without a doubt yes. Unemployment is on the rise, housing is in the dumps and local governments are insolvent.
Question #2: Are stocks bad?
Answer: Without a doubt, no. Earnings have been great and are expected to reach record levels this year.
What is most interesting is that, if you look at it simply, it makes perfect sense. We are going through “The Great Shakeout”, as my good friend Tom likes to say or put slightly differently a “Zero-sum economy”. (That one’s mine but I like his better)
The natural demographic cycle of an aging population who spends less combined with a severely over indebted population desperately in need of balance sheet repairs, cleanly creates less demand in the economy. Less demand leads to less supply needed, so fewer people are required to produce those reduced goods.
However, what companies are doing is simply fighting for survival. They hoard cash and strengthen their balance sheets by cutting costs and laying people off. Naturally, it is survival of the fittest, making the larger corporations better able to survive an economy like this, at the expense of smaller less efficient companies. Some will be bought out, some will merge and some will go by the wayside. The great shakeout. Anyway you look at it, it leads to fewer jobs and a slower overall economy but with very selectively efficient corporations left standing.
That’s the nature of the efficient capitalist system and there’s nothing the government can do about it. The sooner they get out of the way, the faster the real recovery can begin.
What this does is make individual companies very attractive even though the economy “Slogs through the mud” (that one’s mine). It is these large companies that largely represent the major indexes like the S&P 500 which has only 500 stocks or the Dow Jones which has only 30 stocks. And because we focus on these indexes, it looks like the market is rising. Eventually, the bad economy will trickle up to the larger more efficient companies, which will be evidenced with poor earnings. That day is not today.
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