CHAPEL HILL, NC – We can stop debating whether the stock market has become more disconnected from the economy.
It’s undeniably, according to a recently completed academic study by Rene Stulz, professor of banking and monetary economics at Ohio State University, and Frederik Schlingemann, professor of finance at the University of Pittsburgh. But don’t blame this growing disconnect on the COVID-19 pandemic; professors show that the trend for greater disconnection dates back at least five decades.
could reach new all-time highs following record unemployment. They argued that the DJIA of the market,
force tells us nothing about the economy and all we need to know about how our political system rewards the upper classes.On the other hand, many others have argued that since the level of the stock market – in theory – is a function of anticipated future corporate profit growth, there is nothing particularly surprising in its disconnect from what is happening at the same time. Those on this camp therefore celebrate every stock market rally as proof that President Trump’s economic policies are working.
Professors respond to this debate by arguing that it cannot be resolved theoretically. As they write in the study: “To what extent does the stock market reflect the economy is an empirical question.”
They focus on several measures, but perhaps the easiest to understand is the proportion of total employment coming from state-owned enterprises. At the start of the faculty sample in the early 1970s, 41.4% of non-farm workers in the private sector were employed by publicly traded companies. By 2019, this percentage had fallen to 29.0%.
Note that even in the early 1970s, less than half of private non-farm employment in the United States came from publicly traded companies, and that proportion has declined only modestly since then. The disconnection from the stock market economy is therefore not an entirely new phenomenon.
This conclusion was reinforced by what the professors discovered while digging deeper into the data: the long-term trend towards greater disconnection has not followed a straight line. In fact, they found that the current disconnection isn’t even the highest in 50 years.
Consider a faculty-created “measure of non-representativeness of employment” that reflects the extent to which a company’s share of market capitalization in the total market differs from its share of total employment. This metric would be small if the publicly traded company that employed the most people also had the largest market capitalization, and so on. Higher readings would therefore indicate greater “unrepresentation” – greater disconnection, in other words.
The graph at the top of this article shows the measure of the non-representativeness of professors’ employment. Note that while the current reading is higher than in the 1970s, it is not as high as what was recorded at the peak of the dot-com bubble.
Short-term and long-term factors are at play here, according to professors. The short-term factor is market valuation: the disconnect between the stock market and the economy increases as valuations become more strained. This is a worrying finding, given that their measure of unrepresentation of employment is now higher than at any time, except at the peak of the dot-com bubble.
The longer-term factor, professors say, is the shift from manufacturing to a high-tech economy. Typically, high-tech companies employ fewer people than manufacturers. The company currently at the top of the market capitalization ranking – Apple AAPL,
– has 137,000 employees, according to FactSet. On the other hand, when General Motors GM,
led the market capitalization rankings five decades ago, it employed over 600,000 people.
The bottom line: There is a growing disconnect between the stock market and the economy. The strength of the stock market tells us less about the real state of the economy than at almost any other time in the past five decades. And this is not a political belief, but a statement of fact.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected]