“The stock market has been on a tear, yet the economy is in the dumps.” This according to a recent Bloomberg article by columnist Barry Ritholtz, who shares insights on why many “undoubtedly incorrectly” believe that the stock market has “decoupled from reality.”
According to Ritholtz, the explanation lies in the role that the weakest industry sectors play in the market. He notes that, surprisingly, “the most visible and economically vulnerable industries are also among the smallest, based on their market-capitalization weight in major indexes such as the S&P 500,” adding that “markets, it turns out, are not especially vulnerable to highly visible but relatively tiny industries.”
Data on GDP, unemployment and jobless claims paints a weak economic picture, Ritholtz notes, adding, “Market capitalization explains why.”
Some of this year’s worst performing industries include department stores, airlines, travel service companies, resorts and casinos, and hotels. “These are highly visible industries,” that get a lot of media coverage. However, he adds, “they are not very significant to the capitalization-weighted stock market indexes.”
Ritholtz argues that the market is signaling the significance of four industry groups; internet content, software infrastructure, consumer electronics and internet retailers, which account for more than $8 trillion in market value—almost a quarter of the total U.S. stock market value.
“On some level,” Ritholtz concludes, “it’s completely understandable why many people believe that markets are no longer tethered to reality because the performance doesn’t correspond to their personal experience, which is one of job loss, economic hardship and personal despair. But what’s important to understand is that indexes based on market-cap weighting can be—as they are now—driven by the gains of just a handful of companies.”