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Home Publications Blogs Beat the Press Robert Samuelson Looks to the Stock Market to Get Guidance About the Direction of the Economy

Robert Samuelson Looks to the Stock Market to Get Guidance About the Direction of the Economy

Monday, 16 June 2014 08:36

Robert Samuelson agreed to be a punching bag again this morning. His column expressed his concern that the stock market and bond market are going in opposite directions. While the stock market has been rising, which in his view is supposed to mean a stronger economy, interest rates in the bond market have been falling which is supposed to mean a weaker economy.

There are two major flaws in Samuelson's conundrum story. The first is that the stock market is a horrible indicator of the future. Remember when the market plunged back in 2006 giving us advance warning of the economic disaster that would follow from the collapse of the housing bubble? Oh right, the market rose through 2007 and hit a new nominal high in late October of that year, just over a month before the beginning of the recession.

And of course there was the crash in 1987 that foretold of the ensuing recession that didn't happen, or at least not for another two and a half years (after the market had fully recovered). Given the weak relationship between the market's performance and the future state of the economy, it is difficult to believe that anyone would look to the former as predictor of the latter.

The other point is that even in theory the stock market is not supposed to be a predictor of the economy. The stock market is supposed to represent the present value of future profits. In recent years the profit share of output has been extraordinarily high. A likely reason for the surge in profit shares is the weakness of the labor market. If the economy were to get stronger the unemployment rate would fall to more normal levels. This would increase workers' bargaining power and likely lead to a drop in profit shares. This means that if traders in stock anticipated stronger growth, it could be associated with a drop in stock prices since the decline in profit shares would more than offset the higher profits associated with higher GDP.

In short there is no reason, either based on past evidence or in economic theory, that higher stock prices should be taken as implying stronger economic growth. This is another great non-conundrum to keep economic policy types in Washington employed.



Comments (10)Add Comment
written by Squeezed Turnip, June 16, 2014 10:36
Krugman had a recent post on his blog concerning the bond market (motivated in part by this article on Bloomberg). Any comment about the economics on that end of things, Dean?

David Harvey makes some good points in his 17 Contradictions and the End of Capitalism that relate to low rates of return on capital.
written by JDM, June 16, 2014 11:35
And the bond market doesn't tell us about the economy per se. It tells us whether interest rates are high or low. That can have something to tell us about the economy, but I don't think it's so simple as the economy is good or bad, growing or shrinking.

Sock Puppet Enigmas
written by Last Mover, June 16, 2014 11:44
That's why the economy remains an enigma.

says Samuelson in the last line.

Indeed. For example, if price declines revenue increases if demand is elastic, or decreases if inelastic.

What's an economic illiterate like Samuelson to do when the outcome can go either way for the same direction in the causal variable?

Why of course, do what any sock puppet does when at a loss for words. Just throw up your hands and exclaim who knew.

Or maybe, just maybe, this is a freudian slip confessional by a sock puppet who never knew and was just guessing all along while reading from a different playbook written by his economic masters of the universe.
written by Jim Hannley, June 16, 2014 12:19
It's interesting to read Dean's observation that the stock market is a poor harbinger of the economy. It's also interesting that Dean points out that in times of economic growth, Market investors might shy away from it because growth can mean higher employment that leads to higher wage costs for corporations, shrinking profit margins. However, perhaps the most forward looking investors also realize that higher employment also means greater consumer demand. That translates into higher sales for corporations. Lower margins per unit can be offset considerably by greater unit volume.
written by liberal, June 16, 2014 12:46
A likely reason for the surge in profit shares is the weakness of the labor market.

That's true, but I don't think it fully explains things, especially since that advantage has to be at least partly offset by weaker aggregate demand. And while American companies often have international sales, it's not like the rest of the world is doing really well either.

I'm no expert on the subject, but my impression is that at least for nonfinancial companies, a large fraction of their historically outsized current profits are because rates are so low.
written by Barkley Rosser, June 16, 2014 3:19

You misspoke here. The stock and bond markets have not been going in opposite directions and RJS did not say so. Fallng interest rates are the bond market going up, and later in his column RJS actually cites an econmist pointing this out and that we expect the stock market to go up when interest rates go down.

What has RJS so all in a silly bundle is that indeed many were forecasting for the bond market to fall (interest rates to rise), which indeed is usually associated with stock market. So the question has been why have they fallen, and, well, there are lots of theories floating around about that, some of which he discussed. His big focus was on that the falling interest rates imply declining future GDP growth, even as he noted that business econ forecasters have not lowered their forecasts notably.

This is another silly column among many by RJS, but you kind of mislabeled what is silly about it.
Investment Income
written by jonny bakho, June 17, 2014 5:23
For those who live off investment income, stock price rises are an increase in their "personal economy". Samuelson is writing primarily for the investor class, people who don't do wage work for income.

For wealthy powerful investors, short term stock prices matter more than a robust economy.
Leading Indicators
written by Michael Meo, June 17, 2014 10:17
There is an index of leading indicators, and the stock market is one of them.
written by Tarn Asian, June 17, 2014 8:19

Leading Indicators
written by Michael Meo, June 17, 2014 10:17
There is an index of leading indicators, and the stock market is one of them.

So? That doesn't mean the stock market is used as a predictor of economic or even stock market performance. It's like the Hillbilly weather forecaster: if it's wet, then rain is forecast, etc, worthless, really
Why look at stocks for direction..?
written by Lee, June 19, 2014 6:30
It's plainly obvious that when Gold starts to make these sort of moves, that stocks are going to struggle. Growth over?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.