Popular media like to point to the stock market as a real-time measure of the health of the economy. They particularly like the Dow Industrials average. It makes quick, easy news for lazy journalists. Occasionally they do it right, but it’s rare. CNN gets it right here:
Don’t trust Dow 10,000
The stock market is supposed to be a leading indicator, predicting what happens next. But the rally doesn’t mean the nation’s economic woes are over…
…said Rich Yamarone, director of economic research at Argus Research. “But I think there’s a bubble-like atmosphere going on here in the rush back to 10,000. Caution should rule the day. We’re not out of the woods yet.”
Several experts point out than many of the relatively strong earnings reports helping to lift the markets in recent days are being driven by cost cuts, rather than strong revenue growth that would be a better indicator of consumers and businesses being willing to spend again. If businesses keep cutting costs to make the numbers that Wall Street wants to see, that can only put more downward pressure on jobs and wages, and result in weaker economic growth or another downturn.
“The companies are cutting fat, and in many cases cutting bone and muscle. There’s no organic economic growth there,” said Yamarone.
Barry Ritholtz, CEO and director of equity research at Fusion IQ, said that despite their reputation as a leading indicator, the stock markets do a terrible job forecasting the economy.
“Beware of economists pointing to the stock market,” he said. “The rallies tend to be false starts because it’s a reaction to what came before. The sell-offs tend to be overdone because, as they gain momentum, they lead to panics.”