Why Stock Markets Rise While Economy Struggles

Like me, many of you may wonder how the stock market can rise while an economy continues to slump. And, also like me, some of you may wonder if NBC thinks you’re a fool — switching the actresses playing the mom on "The Fresh Prince of Bel-Air" with hardly a satisfactory explanation.

Well, Steven Dolvin, associate finance professor at Butler University, at least tackles the first question in a recent column for Inside INdiana Business.

Consider: Unemployment is still high (9.1 percent in May 2011). The depressed housing market is the most undervalued it’s been in 35 years (according to Capital Economics), with foreclosures expected to jump 20 percent from 2010. According to Gallup poll data, average daily consumer spending has declined 39 percent since May 2008.

Meanwhile, since March 2009, the stock market has basically doubled from its lows. Is this a disconnect with reality?

Not necessarily. Studying data from the 2011 Indiana CEO Survey indicates three reasons why the stock market has risen while the economy continues to struggle:

Companies serve global markets. The survey shows what business issues are important to the Indiana CEOs. While several, such as health care costs, employee retention and recruitment, and consistent execution of business strategy have remained flat in terms of importance, “growing the business internationally” has grown in importance. After slipping in 2008 and 2010 as CEOs focused on keeping their businesses afloat, this issue has increased in importance to its 2007 level.

The larger the company, the greater its international focus. For businesses in the S&P 500 Index, more than half their revenue typically comes from outside the United States. Some receive 80 to 90 percent of their revenue from outside our borders. While this international focus keeps their bottom line strong and their shareholders happy, it doesn’t necessarily translate into money spent in the U.S., helping our economy.

Job growth is a lagging metric. The Indiana CEOs were asked if they were going to reduce or add jobs. The survey indicates what you’d expect in a tough economy and recovery: After the recession hit, the likelihood of reducing jobs rose from 2007 to 2009 before beginning to decline. Meanwhile, the likelihood of adding jobs declined steeply from 2007 to 2009, before beginning to increase.

While the likelihood of more hiring has increased, actual hiring hasn’t yet. Actual job growth lags behind the stock market, which tends to be a forward-looking metric. People make investments based on what they think will happen, rather than what’s happening now. That’s why, in terms of job creation as a component of business performance, the stock market anticipates a rosier picture than current reality.

Trickle down takes time. In the survey, the Indiana CEOs said they believe there is more public and private funding available for business success, compared to last year. They say the amount of funding has increased on both the equity and debt sides since the recession. As funding increases, companies can leverage their positions more. This translates to better returns, which leads to happier shareholders. On this idea of more money = more profits, the stock market rises.