Tuesday, 22 April 2008

Another nice bit from Robert Shiller

About the relationship between stockmarkets and the real economy. A nice bit to re-read after a prolonged exposure to CNBC.

Not only are stock markets small relative to their corresponding economies, but changes in stock prices do not correlate very well with changes in measures of the aggregate economy. But the news media, ever attracted by grand and simple stories, has created the impression that a country’s stock market is like an index of the country’s performance. Ever focused on whether we are entering a recession or coming out of one, the media create the impression that forecasting the stock market is like forecasting recessions.

Thus we tend to imagine that the US stock market is a proxy for the US economy, the German stock market is a proxy for the German economy and so on. But getting past the story telling and looking at the data, one sees surprisingly little similarity between stock prices and the overall economy. Over extended periods of time when the stock market was doing very well, we have had numerous recessions, and over extended periods when the stock market was doing very poorly, we have also had numerous recessions. The recessions really do not matter so much for stock markets’ overall performance. Ultimately, the stock market represents claims only on a small sector of the economy, corporate profits, that does not bear a close relationship to the economy as a whole.

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