The Link Between the Stock Market and the Economy Is Weakening

The stock market is often misused as a bellwether for the economy, especially in political debates. Yet the market has never reliably moved in concert with the economy. And today the connection between the two is weaker than at any point since World War II. The reasons for this disconnect, furthermore, suggest the relationship will loosen even further in years ahead.

One major reason the correlation between equity markets and real economic activity has never been particularly strong is that stock prices are driven by expectations about future, not current economic conditions, and they can also be significantly influenced by changes in the interest rate used to discount future earnings. As the economy has evolved toward services industries such as health care and education, though, and as private equity funds have grown to become a larger force, the stock market has become even less representative of current economic activity.

New research by Frederik Schlingemann of the University of Pittsburgh and Rene Stulz of Ohio State University documents what has happened. In 1973, 41% of private-sector workers in the U.S. were employed by publicly listed firms. By 2019, that share had fallen to 29% percent. And among public firms, employment now plays a smaller role than it once did in explaining market values: In the 1970s, employment differences across companies explained half of the differences in stock market capitalization; they now account for only a fifth of the variation.

What explains the growing gap between stock prices and employment? Schlingemann and Stulz point to sectoral shifts across the economy as being the major driver. Manufacturing companies, with significant physical investment, often turn to equity markets for their substantial financing needs. Services firms are less likely to be publicly listed. Only 4% of workers in education and health services are employed by public firms, compared with more than three-fourths of workers in manufacturing.

Thus, the increasing disconnect between the stock market and jobs is largely a story of the American economy’s shift to services over the past several decades. In 1973, manufacturing employed 30% of workers. Employment in the sector has fallen by more than 2 million people since then, and the share of total employment in manufacturing has declined by almost two-thirds. At the same time, since the early 1970s, employment in education, health services, professional business services, and leisure and hospitality has grown by more than 200%.

If education and health-care firms were as prone as manufacturing companies to tap public equity markets, then listed firms would have represented 43% of all workers in 2019 — slightly more than in 1973. In other words, the shift of employment toward services and away from manufacturing has widened the disconnect between the stock market and the job market.

The mirror image of the public companies’ declining employment share is the rise in private equity. Since 2002, the net asset value of private companies has risen twice as fast as that of public ones, McKinsey estimates. As the number of public companies has fallen in half over the past two decades, the role of private companies has risen.

So what should we expect in the future? The buzz around special purpose acquisition companies, or SPACs, suggests that for many firms the allure of public markets will persist. Overall, though, as people consume more and more health care, education and other services, employment will probably continue to shift toward private companies.

All this raises an interesting question: Do we need new measures of activity among private companies? As the employment share of public companies continues to fall, data from their activities tells us less and less about the broader economy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Peter R. Orszag is a Bloomberg Opinion columnist. He is the chief executive officer of financial advisory at Lazard. He was director of the Office of Management and Budget from 2009 to 2010, and director of the Congressional Budget Office from 2007 to 2008.

©2020 Bloomberg L.P.

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