The Link Between the Stock Market and the Economy Is Weakening

The stock market is often misused as a bellwether for the economy, especially in political debates. Yet the market has never reliably moved in concert with the economy. And today the connection between the two is weaker than at any point since World War II. The reasons for this disconnect, furthermore, suggest the relationship will loosen even further in years ahead.

One major reason the correlation between equity markets and real economic activity has never been particularly strong is that stock prices are driven by expectations about future, not current economic conditions, and they can also be significantly influenced by changes in the interest rate used to discount future earnings. As the economy has evolved toward services industries such as health care and education, though, and as private equity funds have grown to become a larger force, the stock market has become even less representative of current economic activity.