Why Does The Stock Market Not Reflect Reality?

Something interesting happened last year. The S&P 500, which tracks the top 500 companies in the US, was surging. This was despite the global pandemic, unemployment, riots, and an outgoing president refusing to concede the election. The stock market kept climbing despite real-world turmoil. Why is that?

1. The stock market is not the economy

A stock market tries to predict what will happen in the future while economic data reflect what’s happened in the past. Stock market reflects how investors think corporate profits are going to be in the future. But for many people, that measure is meaningless. The future may be bright for the top 500 publicly traded companies but at the same time, smaller non-public companies were struggling to survive.

2. The congress and the Federal Reserve

The US congress has poured in trillions of dollars into the economy through stimulus bills. The stimulus checks have encouraged people to invest the money into stocks. Plus, the Federal Reserve made interest rates 0% - 0.25%, making borrowing and investing money a lot cheaper. Since the bond yield is also low, as an investor, investing in stocks is the only option. On top of that, the government’s measures to stabilize the economy are a reassurance for the investors.

So, even though the stock market is not the economy and the divergence between the two has never been clearer than this, it still offers a window into the economy, telling us where the investors think the economy is headed.