7
The Stock Market and the Real Economy
So far we've established that at the company level, growth and ROIC are key drivers of market valuation (Chapter 2), and that the investors who matter in driving stock prices are the most sophisticated (Chapter 6). In this chapter, we examine the movements of the aggregate market to show how they can be explained by the performance of the real economy (production, consumption, inflation, interest rates, and profits).
By understanding what's driving the market, executives are better able to interpret their own company's share price performance and how their actions may or may not affect it. Of course investors can also benefit from knowing what underlies stock market performance and the extent to which it is aligned or misaligned with the real economy.
A cursory look at the stock market during the past 50 years would tempt you to conclude that its performance has been too wild to be explained by the performance of the real economy. Here are the annualized inflation-adjusted returns on the S&P 500 by decade compared with GDP growth:
| Decade | Real TRS | Real GDP Growth |
| 1960–1970 | 5% | 4% |
| 1970–1980 | 0% | 3% |
| 1980–1990 | 9% | 3% |
| 1990–2000 | 14% | 3% |
| 2000–2009 | −5% | 2% |
While the growth of the economy is very stable across the decades, the stock market returns range from negative 5 percent to positive 14 percent. As you will see later, once we factor in the effect of inflation and interest rates, this performance will make sense.
Ignorance of the ...
