The Great Disconnect
With the economy clearly weak, and potentially getting weaker, this brings me to the disconnect between the financial markets and the economy. Listen to the mainstream media for very long and the general consensus is that the rise in capital markets, given weak current economic data and a resurgence of the Eurozone crisis, is clearly a sign of economic strength. This, combined with rising corporate profitability, makes stocks the only investment worth having. My arguments are much more pragmatic.
First, it is worth noting that the markets have risen to “all-time highs” only on a nominal basis. As I posted in a recent missive entitled “Why You Can Never Beat The Index” I stated that:
“While the markets have hit an all-time high on a nominal basis (due much to the substitution effect as discussed above), there is still much to go before making up lost ground on an inflation adjusted basis.”
The chart below shows the S&P 500 adjusted for inflation. Investors today, if they had been able to get exactly the same performance as the index are now back to where there were effectively in 1997. Of course, the reality is that investors have fared far worse given emotional mistakes, jumping from one investment strategy to another, taking on excess risk, and chasing past returns.
As I explain to my kids in baseball – it is not getting hits that win baseball games but rather having fewer errors than your opponents. In investing – the winner is the person with the fewest errors.”
Setting aside for the moment the impact of all other factors and looking at the rise of the index solely as an indication of economic strength – we find a very large disconnect.
Since Jan 1st of 2009, through the end of March, the stock market has risen by an astounding 67.8%. However, if we measure from the March 9, 2009 lows, the percentage gain doubles to 132% in just 48 months. With such a large gain in the financial markets we should see a commensurate indication of economic growth – right?