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No, the Stock Market Is Not the Economy

Day-to-day swings in the stock market don't indicate anything about an economy's long-term vitality. That's because it only represents a small sliver of U.S. employment.
Traders work on the floor of the New York Stock Exchange on February 5th, 2018, in New York City.

Traders work on the floor of the New York Stock Exchange on February 5th, 2018, in New York City.

In his first official State of the Union address, President Donald Trump painted a resurgent portrait of the United States' economy after his first year in office: two-point-four million new jobs, unemployment claims at a 45-year low, and, most important for a New York-bred business magnate, runaway confidence on Wall Street. "The stock market has smashed one record after another, gaining $8 trillion in value," Trump said. "That is great news for Americans' 401k, retirement, pension, and college savings accounts."

Trump wasn't lying. On January 4th, the Dow Jones Industrial Average closed above 25,000 for the first time; the week after that, the Dow saw its fastest rise between 1,000-point barriers, from 25,000 to 26,000, in just seven days; by January 24th, a week before Trump's address, the Dow shattered records once again. Since Trump's election in November of 2017, the index had gained a stunning 45 percent—and for weeks leading up to his State of the Union address, Trump lauded the "unprecedented success" of the "record stock market." Indeed, Trump has tied his success to the rise and fall of Wall Street.

Then the news came Monday: The Dow had plunged by more than 1,500 points, the largest single-point decline in its 121-year history; meanwhile, the S&P 500 erased all of the runaway gains enjoyed by the U.S. in the first month of 2018. (Though that decline was "was nowhere close to the destruction on Black Monday in 1987 or the financial crisis of 2008," per CNN.)

But in an age where a single tweet can move markets, most analysts suggest no single piece of information triggered the drop—beyond some good old-fashioned fear. The CBOE Volatility Index (VIX), a popular measure of anticipated market volatility commonly known as the "fear index," spiked more than 100 percent on Monday, marking the largest single-day increase in history and signaling unprecedented uncertainty among financial observers.

Has the Trump White House dragged the U.S. economy to the brink of collapse? The short answer is: no. As Vox points out, the markets are still rising, and regulatory measures designed to prevent a truly catastrophic market implosion didn't kick in. But the longer answer is more important: The economy and the stock market are not the same thing in the U.S. (or anywhere else in the world, for that matter).

There are two reasons for this disparity. The first is relatively simple: Stock markets like the New York Stock Exchange are organized, structured markets of select components—in the Dow's case, of 30 major Americans companies; in the S&P, it's 500 companies—that are snapshots of manufacturing, energy, and entertainment industries. But as Deutsche Bank reminded clients with a handy chart in 2015, those goods-producing industries only encompass some 14 percent of U.S. employment—a tiny sliver of the national gross domestic product. The S&P 500 functions as a better bellwether index for the U.S. business environment, even for the likes of the National Bureau of Economic Research, but it doesn't entirely reflect how economic gains are distributed throughout society. A growing body of analysts even claims that markets that radically outperform the actual economy are a critical sign that the stock market is no longer an effective leading indicator.

And this gets to the second problem: The day-to-day fluctuations in the Dow and S&P 500 are something like a mood ring for capital, so far that even a cursory analysis of a contained ecosystem like Twitter could yield potentially actionable insights into the rise and fall of markets. But generally, day-to-day swings don't indicate anything about an economy's long-term vitality: Writing in FiveThirtyEight, Ben Casselman cites economist Eugene Fama's "random walk" theory, explaining that "short-term moves don't reveal anything about the long-term trend."

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Yes, major swings in the stock market can trigger catastrophic selloffs, a cascading tide of panic that federal regulators have worked to avoid since the 1929 crash that sparked the Great Depression. But taken in context, it's deeply unlikely that the Monday drop itself tells us anything about the economy. The Dow dropped off, sure, but the S&P has yet to decline 10 percent from its last high in a "correction" that, though alarming, is still a healthy and natural part of the business cycle. Indeed, Goldman Sachs anticipated a "high probability" of a major stock market correction on January 29th amid tremors in the VIX, the day before Trump's self-laudatory State of the Union address.

The irony, of course, is that if Monday's stock drop is in no way a direct consequence of the Trump presidency, then its gains are in no way a measure of his success. The White House knows this, of course: Back in March of 2017, then-Press Secretary Sean Spicer cautioned the American public against fixating on the stock market as a measure of Trump's success.

"You can't look at one indices and say that that is the benchmark of an entire economy," Spicer told reporters after the Dow dropped 200 points on March 21st. "But you see confidence levels both in small business and in other surveys that show that there's continued confidence in the market and optimism in the market."