Does the stock market reflect the real economy

[i4value]

An economy is about the production of goods and services in a country. In a market economy, the goods and services are mostly produced by companies.

The stock market generally comprising the better companies in an economy.  If the economy does well you would expect these companies to do well and vice versa.

Of course, in the short term the stock market is affected by market sentiments. But in the long run you would expect the stock market to reflect the business fundamentals which in turn is linked to the economy.

Well, this is the descriptive part. Does the number show this? The chart below shows the Bursa Malaysia KLCI and the Malaysian GDP in current USD from 2000 to 2022.



You can see that they share similar patterns although there is no exact year-to-year match. In fact, there is a 0.88 correlation between them.

What does it mean for an investor?

• Invest in a growing economy to have better chances of making money.
  
• Invest in the long-term. 
  
• The KLCI should be up-trending in the coming few years given that the GDP over the past 2 years is trending up.
  

[specuvestor]

GDP vs stock market is a rough rule of thumb which Buffett also uses. And also a lot of people use to justify that China is cheap

But GDP is output ie ~sales. Stock market focus more on profitability though sales is part of the equation. That is why China and US gap is so wide vs GDP.

So while Malaysia GDP quadrupled KLCI about doubled according to the chart.

[i4value]

For the companies making up the index, there is probably a "stable" correlation between revenue and earnings. So while technically the index reflects earnings more than revenue while the GDP is about revenue, you should not be surprised by the link between them

[specuvestor]

yes sales is part of the equation to drive earnings. But this correlation, rather than a measure of relative valuation between markets which also includes effective earnings multiplier on growth, exist in almost all markets I know including KLCI

[i4value]

My point is that in the immediate and short term, the stock market may not reflect the real economy. But over the long term there is a strong correlation. My chart for Malaysia just supports this contention.