The Mystery of the Rising Stock Market

Posted Tuesday, Nov. 3, 2009, at 1:09 PM ET

The Mystery of the Rising Stock Market
If the economy's stagnant, why are stocks up? The answer is disturbing.
By Daniel Gross

Here's a puzzle: The stock markets are doing very well, yet the performance of the underlying economy doesn't seem to justify optimism. The buoyant S&P 500 has risen 53 percent since the March bottom. And while the economy expanded at a 3.5 percent rate in the third quarter, unemployment is high, incomes are stagnant, and consumers are shaky.

It's possible that the stock market is just getting it wrong again. After all, the markets, which are supposed to process investors' attitudes about the future, hit record highs in October 2007, just as the U.S. economy was about to pitch into recession. But it could be that the notion the stock market is an accurate gauge of the domestic economy's temperature is outdated.

The Dow, the S&P 500, and the NASDAQ are primarily indices of large U.S.-based companies, not main street businesses: more Davos than Chamber of Commerce. These increasingly cosmopolitan firms have been busy globalizing and expanding their operations overseas. In 2006, according to Standard & Poor's, 238 members of the S&P 500 broke out revenues between U.S. and non-U.S. sales. These companies notched about 43.6 percent of sales outside the United States. For large companies that had already saturated the U.S. market, the home market was something of an afterthought. In the second quarter of 2007, 66 percent of Coca-Cola's beverage business came from outside North America.

And thanks to the long recession, demand for products and services of all types in the United States has shrunk even since 2006. Yes, the global economy in 2008 experienced its first year of shrinkage since World War II. But growth has resumed, and in some places—Peru, China, India—it never stopped. As a result, the globe's economic geography has continued to change, with the United States accounting for a smaller chunk of global output and demand each year. For much of the past two years, virtually all growth in economic activity has taken place outside America's borders. As a result, U.S.-based companies are becoming even more reliant on non-U.S. customers and operations for sales. S&P last summer updated its numbers. In 2008, the figure rose to 47.9 percent (with 253 of the 500 companies reporting), up from 43.6 percent in 2006. Put another way, in two years, big companies' proportion of sales coming from outside the United States rose 9.8 percent. It's likely the 2009 figure will be something very close to 50 percent.

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