It's another beautiful Sunday afternoon in San Francisco. So you take a good book to the park to enjoy the sunshine.
You glance up from your book and see a man walking his dog. The man is maintaining a nice, steady pace as he follows the path through the park. His dog, being a dog, is running all over the place. The man has a firm grip on the leash so the dog never strays too far, but the pup goes in whichever direction his nose takes him - he's off to one side, then off to the other, then he runs ahead only to stop suddenly and dart behind his owner.
Watching the man is pretty boring. He changes his pace a little and stops to check his watch, but otherwise, it's a slow, boring walk through the park.
Instead your eyes are drawn to the dog. He's chasing pigeons and saying hello to other dogs and stopping to pee. You never know where his canine-brain will lead him next. But you're still pretty sure he'll wind up at the end of the path with his owner. He's on a leash, after all.
The owner is the economy.
The dog is the stock market.
Watching the day-to-day, week-to-week, year-to-year "action" in the markets is much more interesting than watching the economy. And yet, the markets go where the economy goes because they are on the same path.
Here's a (very) simplified explanation of that path. As people grow throughout their career, they obtain steadily increasing skill sets which leads to earning more money. As they earn more money, they spend more money on goods and services. As they spend more on goods and services, American businesses grow and profit. As American businesses grow, so does the economy.
If you own a stock, you own a piece of a company. As that company grows (see above), your piece of the ownership becomes more valuable as reflected in the stock price. The collective growth of all these publicly traded companies make up the growth (long-term investment returns) in the stock market.
Just like the man and his dog, both the stock market and the economy are on the same path. The economy grows slow and steady. It may change pace or stop to check its watch, but we know it will keep growing.
If the economy is growing, the stock market will too. But it won't just change pace or stop to check its watch. It'll chase pigeons, smell friends, and get scared by passing bicyclists.
Here's 60 years' worth of evidence. The blue line is the S&P 500 (the market). The orange line is U.S. GDP (the economy).
The takeaway? Pay more attention to economic news than market news. You'll be less likely to be led back to the fox's den (as discussed last week).
Here's some economic news from last week to get you started:
U.S. first-quarter GDP revised up
U.S. consumer spending rises
U.S. data offers hope for manufacturing; jobs market steady