Pundits in 2020 kept tell us "the stock market isn't the economy." So where should we look when making big financial decisions?
Published April 2, 20214 min read
Because stock market performance is always in the headlines, people sometimes treat it as an indicator of how the economy is doing overall. This can affect how we make long-lasting financial decisions like whether to change jobs or buy a house.
But as stocks soared in 2020 while the country went into recession, pundits regularly reminded us: The stock market isn’t the economy. But if the stock market isn't the economy, what are the indicators we should actually look at to understand the economy is going and where it might be taking us?
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The stock market has never been a good indicator of what's happening in the economy, said Mayra Rodriguez Valladares, a financial risk and capital markets consultant. Rather, it's a leading indicator, showing how investors feel about the future. It’s also become increasingly inflated by low interest rates, Rodriguez Valladares said. Because interest rates have been so low for so long, the stock market is one of the few places to get a decent return on your money. This is why investors keep piling money into the market even during downturns.
As a result, Rodriguez Valladres said, "The stock market has been frankly quite overpriced."
Because the stock market's ups and downs are so prevalent in the news, its performance can influence our thinking when we're making big financial decisions. But if it's not the best indicator to guide those decisions, what is?
It depends on the decision. One of the biggest purchases most people make is buying a house.
Of course, the most important factor is how much money you have saved up. But the ideal time to buy a house also depends on interest rates.
A 1% difference in the interest rate on your mortgage can swing the total cost of your loan by thousands, or even tens of thousands of dollars. While mortgage rates have crept up, they're still near historic lows.
"I tell people there's no time like the present to buy a home," said Robert Johnson, professor of finance at Creighton University's Heider College of Business.
Interest rates don't tell the whole picture. A lot of economic factors, including the supply of housing or the job market in the area you're looking at can affect the real estate market. But they're a good place to start.
Another big financial decision is whether to change jobs. Hot stock market, hot job market right? Not necessarily.
The unemployment rate is a widely reported economic indicator that can tell you about the job market at large, but it's likely not that informative on an individual level. However, the Bureau of Labor Statistics, the government agency that calculates the unemployment rate, also tallies the unemployment numbers by industry.
These figures are especially uneven now as the country undergoes a so-called "K-shaped recovery" from the pandemic-sparked recession, with some industries, like the hospitality industry and the movie industry, suffering greatly and others, like finance or technology, doing just fine.
But when you're making big financial decisions, you need to look at your personal economic indicators. For example, the size of your emergency fund is much more important than the unemployment rate if you decide to quit your job. Your mortgage lender will set your interest rate based on your credit score, not so much the state of the economy at large.
The stock market does play a huge role in the timing of your retirement. When you're investing over decades, the stock market is a good way to get a good return.
If your retirement portfolio is filled with stocks, then the ups and downs of the market will have an impact on how much you can expect to live on when you stop working. Stocks offer great reward, but also great risk.
But even then, you don't need to check the Dow Jones Industrial Average every day, especially if your retirement is decades away. Historically, stock prices have trended upward, regardless of any day-to-day volatility.
As you approach retirement, it makes sense to rebalance your portfolio so it's weighted toward more stable investments like bonds. But there's no need to adjust to every market movement.
"Because you can turn on your television or radio and you see how the stock market did today, a lot of people see it as, 'Oh, this is what's going on in the economy,'" Rodriguez Valladeres said. "It's not."
Image: Getty Images / Dowell
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