Put Aside the Focus on the Economy

Time provides a great overview of why “It’s Not The Economy” that investors should focus on:

A recent story on the daily peregrinations of the stock market concluded that, at least for the day, “U.S. stocks erased their losses to finish in positive territory, as investors weighed an improving domestic economy against heightened global concerns.” That seems an innocuous enough statement. The markets did well because investor concerns about the economy were allayed by some data or shift in sentiment. Pretty simple, right? Yes, but also pretty wrong.

Reading markets in light of economic data is common, but it is using a deeply flawed lens. Not only can markets rise when the economy is weak and fall when the economy is strong, but the fate of an increasingly large number of companies has little to do with the fate of their home countries. Using national economic data as a barometer of companies and stocks may have once made sense — when firms were intimately tethered to their homelands — but no longer. In fact, using national economic data as a guide to how companies will perform is almost certain to lead to the wrong conclusions.

In part, this is because companies have become increasingly global in their business, especially publicly listed companies that trade on the world’s stock exchanges. Nearly 50% of the earnings of the S&P 500 companies came from outside the U.S. last year, and if you take out companies that are closely tied to the American economy such as utilities and health care services, that percentage is almost certainly above 50%. Even some prominent, dynamic U.S. consumer companies like Nike are seeing their most dramatic growth by selling to China and its rapidly emerging middle class, along with a host of other emerging countries. The swoosh is as familiar in Guangdong province as it is in Galveston, Texas.

So while there remain industries like health care that are inextricably linked to the domestic economy, those are the exceptions. The new rule for investing should be to put aside the quaint notion that getting the economy right helps you get stocks right. Once, what was good for GM might have been good for America, but that was another time, another age, one that should be remembered as history. And only as history.

This is a pretty good argument for allowing price trends to dictate allocations as opposed to obsessing about the growth of “the economy.”  As pointed out in the article, the U.S. economy will be fortunate if it ekes out 2% to 3% growth this year, while S&P 500 third quarter earnings grew by an astonishing 31% (year over year).

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