When we think of financial health, a few things might come to mind. We may think of our own financial status, our investments, the S&P/TSX Composite performance, the stock market as a whole, the economy, the country’s employment status and so on. While some aspects may be interrelated on some level, they are not all one and the same, nor do they all indicate the status of one another.
The various ways we can characterize financial well-being speaks to why so many people think of the stock market and the economy’s health as a gauge for each other. However, the stock market does not define economic health as a whole. As we’ve seen with COVID-19, stocks are back on the rise, but many individuals - and the country as a whole - are still facing the effects of business closures, record-breaking unemployment rates and more. So why is this? Below, we outline the major differences between the stock market and the economy and why one can progress while the other tells a different story.
What Is the Economy?
The economy can be defined as “the wealth and resources of a country or region, especially in terms of the production and consumption of goods and services.”1 More specifically, one way we can understand economic activity is through real GDP (gross domestic product), which measures the value of goods and services while factoring inflation into the equation. As a result, understanding the health of the economy can be thought of in terms of the growth rate of real GDP, meaning whether or not the production of goods and services is increasing or decreasing.2
Economic Health in Terms of GDP and Employment
Naturally, employment may rise as production and consumption increase. To produce more goods, companies and factories might hire more employees to complete such production. With more individuals employed and gathering paychecks, more people have money to spend on such goods - increasing overall consumption. Sometimes, however, GDP can grow but not quick enough to create more jobs for those who are unemployed.2
What Is the Stock Market?
The stock market is a place where the shares of companies that are publicly owned can be bought and sold.3 The stock market is composed of the buyers and sellers (with some buyers and sellers holding more “stock” than others) and is not necessarily indicative of every business, worker and family.
The main index used to understand how the market is performing is the Canada S&P/TSX Toronto Stock Market Index.4
The Stock Market vs. The Economy in the Context of COVID-19
The stock market and the economy can display very different pictures of “progress.” One such example is with COVID-19. In regards to the stock market, the major index, the TSX, dropped in March before maintaining a consistent return.4 On the other hand, GDP decreased by 11.5 percent in June 2020.5 While the total percentage of unemployed individuals rose to 13.7 percent in May.6 Why is there such a disconnect? A few reasons below.
When considering the make-up of the TSX index, the stock market isn’t representative of all who make up the Canadian economy. It is largely made up of companies that are different from small businesses, workers and cities in Canada - with different profits, greater access to bond markets and global positioning.
The stock market’s performance as a whole only represents a portion of the Canadian employment market. A study conducted by the Parliamentary Budget Officer (PBO) showed that the wealthiest one percent of households in Canada were in control of 25 percent of the total wealth of the country.7 This totals nearly five times the average yearly GDP for the entire country.8 Therefore, the stock market may not represent the majority of households that come to form the total economy.
It’s long been understood that at times, investors may be driven by emotional or reaction decision-making. As a result, their behavior may not be mimicking the economy’s current state nor affairs happening in real-time.
While the stock market may reflect some changes in the economy and vice versa, the status of one does not show the entire portrait of the other. At times, they can tell entirely different stories, as is the case with COVID-19. Considering other factors such as unemployment can provide a fuller depiction of the state of the economy and the financial well-being of its residents.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.