[Square] Is the Stock Market Always a Mirror of the Economy?

There has been a surge of questions recently directed at securities firms' research centers. The main concern is the discrepancy between the stock market and the real economy. Despite various economic indicators struggling and growth rates expected to contract due to the novel coronavirus disease (COVID-19), why do stock prices continue to rise? Moreover, many ask why their own stocks do not increase in value even as the stock indices climb day after day.

In fact, even for the author, who has observed stock market trends for over 20 years, these questions are not only difficult but also perplexing. Although I consider myself an expert who has analyzed companies and markets over a long period, it is not easy to provide clear solutions or answers when investors make decisions directly. Furthermore, when the economy and stocks move separately as they have recently, the difficulty of these questions doubles.

In reality, the economy and the stock market are inseparable. The stock market is the fastest and most direct reflection of a country's economic situation, and naturally, the economy is the true image reflected in this mirror called the stock market. However, the mirror and the actual image can sometimes show significant discrepancies or even project completely different appearances. While they are highly correlated, the stock market does not necessarily have to be the economy itself, nor does the economy have to perfectly align with the stock market.

There are four main reasons why the stock market and economic conditions can diverge. First, there is a structural gap between the companies listed on the stock market and all companies in the economy. Although there are countless companies in a country, only a very small fraction are traded on the stock market or included in indices. In the United States, for example, out of 6 million companies, only about 4,000 (0.07%) are publicly listed. The Standard & Poor's (S&P) 500 index selects only the top 500 companies among these.

Second, the trap of averages. When people say the stock market is rising, they usually mean the representative index of that market is going up. However, most stock indices are highly sensitive to the stock prices of large companies with significant influence on the index, and recently, IT giants have been leading the price increases in both the U.S. and Korea. The top 20 companies account for 25% of the S&P 500's market capitalization, and in Korea's KOSPI market, Samsung Electronics alone accounts for more than 20%. To add, if the stocks you hold are among those leading the rise, there is no problem, but for investors holding other stocks, the market's rise becomes someone else's story.

Third, policy factors. The spread of COVID-19 has undoubtedly had a negative impact on the overall economy. The shock was enormous and brought the economy to a near "all stop" in a short period. However, the greater the shock and its ripple effects, the more likely solutions and policies will be implemented in response. Central banks around the world lowered benchmark interest rates and actively injected liquidity. Moreover, these policies are likely to continue for a considerable period even after the COVID-19 shock has somewhat subsided. Whether it is Jerome Powell, Chair of the U.S. Federal Reserve, or Lee Ju-yeol, Governor of the Bank of Korea, the recent consensus among monetary authorities is to maintain accommodative monetary policies until the economy fully returns to its normal path after the COVID-19 aftermath.

Fourth, the stock market reflects not only the current economic situation but also expectations for the future. Despite ongoing weakness in the real economy, stimulus measures continue, and as mentioned earlier, the top companies listed on the stock market may secure even greater profits and market dominance after COVID-19. Therefore, even if current economic conditions or earnings are weak, there is little reason for stock prices to fall significantly. It is clear that the economy and the stock market are a closely related "set." However, it is also important to remember that there are many reasons explaining the differentiated trends between the two, making it difficult to say the stock market always reflects the current state of the economy exactly.

Jeong Yeon-woo, Head of Research Center, Daishin Securities

This content was produced with the assistance of AI translation services.