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The power of the stock market tells us less about the true state of the economy than at any other time in the last five decades

CHAPEL HILL, NC – We can stop discussing whether the stock market has become more detached from the economy.

Undoubtedly, according to a just-completed academic study by Rene Schultz, a professor of banking and monetary economics at Ohio State University, and Frederick Schlingemann, a professor of finance at the University of Pittsburgh. But don’t blame this growing disconnect from the COVID-19 pandemic; professors show that the trend toward greater disunity dates back at least five decades.

Prior to this study, the debate over the disruption of the stock market economy generated more heat than light. As usual nowadays, it was highly politicized. On the one hand, it was indecent for many that the SPX stock exchange,
+ 1.64%
may reach new record highs after record unemployment. They claim that DJIA in the market,
+ 0.87%
power tells us nothing about the economy and everything we need to know about how our political system rewards the upper classes.

On the other hand, many others argue that since the level of the stock market – in theory – is a function of the expected future growth of corporate profits, there is nothing particularly surprising in its exclusion from what is happening at the same time. Therefore, those in this camp celebrate every stock market rally as proof that President Trump’s economic policies are working.

Professors respond to this debate with the argument that it cannot be solved theoretically. According to the study: “The extent to which the stock market reflects the economy is an empirical question.”

They focus on a few measures, but perhaps the easiest to understand is the share of total employment that comes from public companies. At the beginning of the sample of professors in the early 1970s, 41.4% of non-agricultural workers in the private sector were employed by publicly traded corporations. In 2019, this dropped to 29.0%.

Note that even in the early 1970s, less than half of non-agricultural private employment in the United States came from publicly traded companies, and that share has declined only moderately since then. So the disruption of the stock market economy is not a completely new phenomenon.

This conclusion was reinforced by what the professors found in deepening the data: The long-term trend towards greater disunity does not follow a straight line. In fact, they found that the current exclusion was not even the highest in 50 years.

Think of a “measure of non-representativeness of employment” created by professors, which reflects the extent to which a company’s market capitalization share of the common market differs from its share of total employment. This measure would be low if the publicly traded company that hires the most people also has the largest market capitalization, and so on. Therefore, higher readings would show greater “unrepresentativeness” – in other words, greater disunity.

The graph at the top of this article depicts the measure of non-representation of professors’ employment. Note that while the current reading is higher than in the 1970s, it is not as high as what is registered at the top of the internet bubble.

According to the professors, both short-term and long-term factors work here. The shorter-term factor is market valuation: The break in the stock market economy increases as valuations become more strained. This is an ominous finding, given that their measure of non-representation in terms of employment is now higher than at any other time, except at the top of the internet bubble.

According to professors, the longer-term factor is the transition from manufacturing to a high-tech economy. As a general rule, high-tech companies employ fewer people than manufacturers. The company is currently at the top of the market capitalization ranking – Apple AAPL,
+ 6.35%
– has 137,000 employees, according to FactSet. In contrast, when General Motors GM,
+ 0.15%
was at the top of the market capitalization rankings five decades ago, employing over 600,000 people.

The bottom line: There is an expansion of the link between the stock and economic economies. The strength of the stock market tells us less about the true state of the economy than at any other time in the last five decades. And this is not a political belief, but a statement of facts.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment bulletins that pay a fixed audit fee. You can contact him at mark@hulbertratings.com.

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