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The Mythology of the Stock Market

Photograph Source: Katrina.Tuliao – CC BY 2.0

The stock market enjoys a mythological place not only among mainstream media types, but also among many progressives. For some reason this measure of expected future corporate profits is taken as a measure of economic well-being.

The fact that the media obsesses over the stock market hardly needs to be mentioned. If there is one item about the economy that we can be sure will be repeated every day, it is the movement in the Dow or the S&P 500. And, needless to say, an upward movement is good news and a downward movement is bad news.

But the view that the stock market is telling us something about the well-being of the economy goes far beyond just ill-informed media types. In the lead up to the 2016 election, Justin Wolfers, a University of Michigan economics professor, and a fellow at the Peterson Institute for International Economics, had several New York Times pieces arguing that the wise investors in the stock market recognized that Trump would be bad news for the country. He pointed to sharp declines in the market in response to events making a Trump win more likely.

The Wolfers hypothesis suffered a serious setback in the weeks and months immediately following the election. The S&P 500 was up more than 5 percent in the first month after Trump’s victory. It continued to rise throughout 2017, hitting a peak in January of 2018 that was more than a third higher than its value on the eve of the election.

Wolfers was far from the only one taking stock market movements as a measure of economic well-being under Trump. When the market slumped last fall, there were many Trump critics who seized on this as evidence of Trump’s failings as a manager of the economy.

This view that the stock market is a measure of economic well-being is bizarre, because it is so completely at odds with what the stock market is. The stock market is a measure of the expectations of future profits of companies that are listed in the exchange: full stop.

That is not some left-wing radical analysis of stock prices, this is the textbook definition. The stock market is not going to rise because people are getting better health care and living longer lives. It won’t rally because workers are getting paid family leave and guaranteed vacation. And, it certainly won’t rise because workers find it easier to organize and union membership soars.

Investors in GE, Microsoft, and the other corporations on the stock exchanges will ask how each of these events will affect the future profits of the companies in which they hold stock. If these changes leave profits unaffected, then there is no reason for stock prices to change. If they are likely to lead to lower future profits, as would be the case with increased union membership, then we should expect stock prices to fall.

It is important that people be clear on this point as the 2020 elections draw closer. Many of the policies being proposed by the leading Democratic candidates would be expected to reduce after-tax corporate profits. This means that they should be expected to lead to lower stock prices.

For example, most of the Democratic presidential candidates are advocating strong measures to address climate change. These measures will almost by definition mean sharply lower demand for oil and natural gas. This will mean sharply lower profits for a major sector of the economy, which will surely depress the stock price of fossil fuel companies.

In the same vein, most of the Democrats are proposing measures that will sharply reduce the profits of the insurance and prescription drug industries. These measures should be expected to lead to sharply lower stock prices for the companies in these sectors.

The same story applies to the tech sector, where at least some of the candidates, most notably Elizabeth Warren, have proposed measures to break up dominant firms like Facebook and Google. These measures would be a big hit to some of the most highly valued companies on the market.

Similarly, measures that increase workers’ power and make it easier for them to form unions should also be a hit to profits. Workers will get a higher share of income, and companies will get a smaller share.

In all of these cases it is possible that lower profits in some sectors will mean higher profits in others. For example, reduced demand for fossil fuels will be associated with increased demand for solar and wind power and electric cars, however it is very unlikely that these effects will be fully offsetting. This is especially the case where progressive policies will mean lower after-tax profits for the corporate sector as a whole, such as increased union power or higher corporate tax rates.

Trump will undoubtedly point to any declines in the market associated with favorable polling news for Democrats as evidence that having Democrats in power will be bad for the economy. It is important that Democrats are able to fire back by saying that they will be great for the economy, they will just be bad news for Donald Trump’s rich friends.

It is worth noting that there have been times, most notably in the 1950s and 1960s, when we had very strong economic growth, with widely shared benefits, with stock prices that were far lower relative to the economy. So the idea that we cannot have a rapidly growing economy with a much lower stock market not only contradicts economic theory, it is also contradicted by a large amount of evidence.

Obviously some people will be hurt by a falling stock market, but because of the incredible inequality of stock holdings, the vast majority of the losses will be incurred by the richest 10 percent of the public, with the top one percent seeing close to 40 percent of the losses.

There will be middle-class people that see some hit to their retirement funds, but this just goes back to that old saying, if you think you have an effective policy that doesn’t hurt anyone, then you don’t understand the policy. We need to make fundamental changes in many areas, and this will almost certainly mean a decline in the stock market. We need to acknowledge this fact and recognize that reining in bad practices in the corporate sector is good for the economy of the country and the world, even if it is bad for investors, some of whom are not rich.

Anyhow, getting economic reporters to understand the stock market and its relationship to the economy before the 2020 election will be a difficult task. However, an important first step will be getting the progressives who write and talk about economic policy to understand this relationship.

This article first appeared on Dean Baker’s Beat the Press blog.

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Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

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