Bad news for the economy = Good news for your portfolio?

Investors’ actions often have more to do with irrational feelings than hard facts, and so the markets are often a bit out of sync with other economic indicators. Consequently, bad news for the economy is not necessarily bad news for your portfolio.

I recently came upon some data that wonderfully illustrates this little paradox, and it also offers some hints for how smart advisors (like you!) can exploit it.

This is a lot to take in at first glance, I know. But all of the above charts show basically the same thing: namely, how certain key economic metrics (GDP, payrolls and corporate earnings) tend to lag behind the S&P 500 during recessionary periods. Here is one of them up close:

Notice how the bottom of the S&P 500 (blue line) happens before that of any of the other curves? You will find the same thing on all the other charts too, though you may have to squint to see it. This means that, in each of these recessions, the overall stock market began to improve even as other aspects of the economy kept declining.

Why is this important? Well, consider all the recent bad news from corporate guidance and big tech layoffs, for example. I have been hearing from worried investors who take that as a sign that they should start pulling out of the market, even though their portfolio is currently on the upswing.

But if they do so, they will likely miss out on future earnings rather than dodge future losses. Yet another reason why skittish investors are less successful.

As if to prove the point, just yesterday the markets had a wild heyday… largely because the latest inflation numbers were not as bad as expected. If that seems like a disproportionate reaction, well, it is. Investors got excited yesterday not because inflation is actually dropping, but because they now had evidence that it might drop in the future.

People tend to assume that markets follow the economy, but in fact they often anticipate it. This disconnect is so common, in fact, that more savvy investors will often use broad market sentiment as a contrarian indicator. That is, they will get bullish when the majority of investors are feeling bearish and vice-versa.

So, to borrow what is probably Warren Buffett’s most famous quote, “be greedy when others are fearful and fearful when others are greedy.” And do not let the headlines dictate your investment decisions.