Here’s what makes intuitive sense. If the economy is good, then the markets should be good. If the economy is doing badly, then markets should be doing badly. Over the long term, that’s roughly true as positive trends are rewarded, but no short-term individual moment of the markets can be predicted. Moreover, the medium term trends may vary because the markets – determined by the collective actions of millions of investors – aren’t always reacting to a general economic backdrop in an absolute sense. Instead, the medium term direction of the market is just as often determined by the relative difference between the economy’s (or an individual company fortunes, if you want to get granular) various expectations of the future.
In other words, everything can be going fine, even great, but the markets don’t necessarily go up unless some new improvement – something not already baked into the current set of market forecasts – occurs.
With that backdrop in mind, let’s consider the past few weeks. It has been a little rough; only 3 days of the past 13 days have been positive. Thinking more broadly, there have been a lot of upward economic and market momentum over the past 18 months built on higher confidence levels and easier corporate profits. Therefore, the room for additional growth – upside-potential – necessarily becomes more limited as these positives become realized. Meanwhile, the negative potential catalysts – like tightening monetary policy or trade scuffles – are ever present.
Given limited upside potential, a little bit of profit-taking is perfectly reasonable, even if the economy remains healthy and is expected to remain. It is important to reiterate that many Wall Street firms are only calling for a slowing of economic growth over the next year or so, not a recession. The markets are bouncing around not because the real world economy is bad, but simply because there are limits to how good economic conditions can be and, given years of stability and a sugar-rush of debt-driven cash, we’re roughly there already.