Weekly Economic Trends and Indicators
On Friday, the S&P 500 stock index closed above 5,000 for the first time in its history. This is the latest in a series of record high levels for all three of the major stock indexes (Dow, S&P and NASDAQ) in recent weeks.
While the performance of the stock and bond markets is not always directly correlated to the performance of the broader economy, there are important connections between Wall Street and Main Street that we should note. Specifically, financial markets aggregate a tremendous amount of information about the broader economy and send signals to consumers and firms that can influence current and future economic activity.
At a basic level, the price of a stock reflects the market’s expectations of a company’s future earnings. The current records being broken on Wall Street are an indication that investors believe that these companies are growing in value and will provide a good return on investment.
This is what we tend to see in the middle part of a period of expansion. The current expansion is a continuation of the post-COVID recovery. Inflation, supply chain problems and weak demand in some sectors during and immediately post-COVID, restricted the growth of many companies. As inflation eases, supply chains improve and consumer demand improves, thus a surge of investment activity.
One of the main stories of 2023 concerned advances in artificial intelligence (AI), which has driven investment in data centers by big-name tech companies. As this sector matures, it will lead to spillover effects in other industries. As we saw with the Internet (as well as previous revolutions), technological advances led to efficiencies throughout the economy. Those expectations are now being built into equity prices. It is possible that AI is one of those generational advances that will bring higher productivity and change the way people do business.
Another reason for improved expectations in equity markets is the expected decline in interest rates later this year as inflation continues to ease, and the Federal Reserve begins to change its stance on policy easing. As confidence in a “soft landing” improves, market participants expect higher consumer spending and business investment. This is independent of special considerations like advances in AI. Markets are forward-looking and as the future outlook evolves, prices change.
On the consumer side, higher stock returns create a wealth effect for people who have significant investments in the stock market (including retirement savings). They also can boost consumer confidence. As people see their investments rise in value, they are willing to spend more on housing, autos and other durable goods. This, in turn, is good for construction and for manufacturers of those goods, some of which are located right here in the Quad Cities region.
Of course, record runs do not last forever and expectations can be wrong. The key is to understand why we are seeing the things we are seeing. We want to understand how markets respond to what is happening in the broader economy and how it impacts consumers and businesses on Main Street, whether the markets are going up or down.
Next week: Financial markets, continued (the bond market)
