It often looks paradoxical: unemployment is rising, GDP growth is weak, inflation remains high – yet the stock market breaks records. This is not a new phenomenon. In fact, it happens regularly because markets and the real economy measure and reflect very different things. Let’s break down why this happens, when the trend could reverse, and how to detect it in time.
What Markets Measure and What the Economy Measures
First of all, there is an important distinction:
Stock markets reflect expectations about future corporate earnings, interest rates, monetary policy, and investor expectations. They “price” the future, not the present (or, to a large extent, not only the present).
Macroeconomics (GDP, unemployment, inflation, consumer demand) shows how things are now and a little while ago. It often lags behind: data on unemployment or GDP growth “lags” behind what is already happening or what investors expect to happen.
This creates an artificial paradox: the economy is currently struggling, but the markets have already priced in expectations of improvement.
Why Markets Can Grow Even When the Economy Is “Not in Good Shape”
Here are the main reasons and mechanisms that often lead to this phenomenon.
1. Expectations of Improvement and Discounting
If investors believe that the current difficulties are temporary and that improvements will soon follow (for example, that the central bank will lower rates, that the stimulus package will work, that inflation will begin to fall), they will start to factor this into stock prices today. In other words, the market “jumps” over bad quarters, focusing on the future.
2. Central Bank Policy/Interest Rates
When the refinancing rate is high and rising, it “weighs down” future cash flows – the discount factor is large, and stock price growth is restrained.
If rates are expected to fall or their growth to slow, this gives the market a boost (even if the data is poor now). But if the markets are confident that the Fed/central bank will ease, stocks will rise.
Example: The US Federal Reserve’s recent decision to cut rates after a period of increases has stimulated optimism.
3. Weak Dollar / Favorable External Position
When the dollar weakens, companies with a significant share of revenue from abroad receive a bonus: their foreign sales grow when converted into dollars. This can support profits, especially for technology and export-oriented firms.
4. Strong Segments of the Economy
Not all parts of the economy have been affected equally. Some industries, like technology, AI, “new” sectors, can show excellent growth, innovation, and profitability, even in conditions of weak overall GDP and high inflation. If large companies from the technology sector have a significant weight in the index, they can pull the index up, even if the broader economy is not doing so well.
5. Expectations of Monetary and Fiscal Stimulus
When markets believe that the government and/or central bank will intervene (e.g., cut interest rates, inject liquidity, offer tax breaks, support infrastructure spending), this bolsters risky assets. Even the mere expectation of such intervention can be a powerful driver.
6. Lagging Macroeconomic Indicators
As already mentioned, unemployment, GDP slowdown, etc., often “lag” behind the economic cycle. That is, when companies and investors have already seen that conditions are deteriorating, they already factor their assumptions into prices. And when “bad” data appears, it is often already partially accounted for.
7. The Difference Between Corporate Profits and Revenues vs. “Real Economy” Growth
Corporations can optimize costs, raise prices, pass on inflation, use technology, manage supply chains more efficiently, and increase productivity, which allows them to maintain or even increase profits even when consumers are struggling.
8. Risk and risk premium
In times of uncertainty (economic, geopolitical), some investors still “bet” on growth, expecting that “the worst is over” and that the market is undervalued. Also, some of the “free money” (liquidity) is looking for returns – if bond yields are low and interest rates are extremely high, this makes stocks a more attractive risk.
Specific Elements of The Current Time (2025)
To connect with reality now here is what can be seen from reports and analytics:
- The first Fed rate cut in some time: the market has already priced in this expectation.
- Inflation is still high, but there are signs that it may stabilize or decline, which would reduce pressure from the central bank.
- Sharp focus on technology sectors, including AI: these businesses are perceived as capable of delivering high growth rates even in “bad” macroeconomic conditions.
- A weak dollar helps companies with exports and global revenues.
- Markets react to “negative” news as positive in terms of policy: bad data increased expectations of easing. This is a kind of “optimism through pain”: the worse the data, the greater the pressure on the Fed to cut rates, and the higher the chance for stocks.
Limitations and Risks
However, it is important to understand that such a discrepancy cannot continue indefinitely without consequences. Here is what to look out for:
- If expectations are not met (inflation does not go down, growth does not resume, rates remain high), markets may “bite off” the excess.
- If companies start publishing poor reports confirming a decline in demand or rising costs, then expectations-based valuations will be revised downward.
- Higher interest rates on debt and expensive financing will hurt companies with large debts.
- External events such as geopolitics, supply chain disruptions, and shocks (energy, ideology, climate, etc.) could dampen optimism.
Conditions Under Which the Market Could Break the Upward Trend
1. Inflation Is Not Falling
- If inflation remains persistently high or accelerates again, this will limit the Fed’s ability to cut rates.
- In a scenario of “protracted inflation,” companies face rising costs, lower demand, and reduced opportunities to raise prices.
2. The Fed or Other Central Banks Maintain a Tough Stance
- If the regulator says, “We will not cut rates until we see real improvements,” the market may quickly recalculate its assessment.
- Important: It is the Fed’s rhetoric that can break the trend. Even a single speech by Powell or FOMC minutes can change the mood.
3. Weak Corporate Reporting
- If companies start showing a decline in revenue, profits, or future projections over several quarters, this is a direct blow to the “optimistic” assessment.
- It is especially important to look at the tech giants and “index drivers”: Apple, Microsoft, Alphabet, Nvidia, and Amazon. If they disappoint, the index falls.
4. Rising Unemployment, a Blow to Consumer Demand
- The market can ignore bad data for a long time, but if unemployment starts to “accelerate” and clearly hits retail, credit, and consumption, investors begin to revise their expectations.
5. Financial Crises/Debt Risks
- If the number of corporate defaults and problems in the banking system increases (as in 2008 or the recent crisis of regional banks in the US in 2023), even the Fed’s soft policy will not save the day.
6. Geopolitical or Energy Shocks
- Wars, new trade conflicts, and spikes in oil and gas prices can sharply dampen optimism because they are direct threats to economic growth.
How to Spot That Growth Expectations Have Not Been Met
Here is a set of “early indicators” used by professional investors:
1. Bond Market (Yields and Yield Curve)
- If long-term bond yields are rising (the market is demanding a premium for inflation/interest rate risk) and stocks continue to rise, this is a sign of dissonance.
- A yield curve inversion (when short-term rates are higher than long-term rates) usually precedes recessions.
2. Forward Earnings per Share (Forward P/E)
- If indices are rising but corporate earnings expectations are falling, multiples are “inflated.” This is a bubble.
- Keep an eye on consensus prognoses from analysts (FactSet, Bloomberg): if EPS (earnings per share) for the coming year is regularly being lowered, but the market is still growing, a correction is coming soon.
3. Declining Market Breadth
- If only a few giants (Nvidia, Apple, etc.) are growing, while most “broad market” stocks are falling or stagnating, this is a bad sign.
- Indicator: compare the dynamics of the S&P 500 and Russell 2000 (small companies). If the gap widens, growth is “fragile.”
4. VIX and Volatility
- If the Volatility Index (VIX) begins to rise amid market growth, it means that investors are starting to hedge, and the market does not believe in a sustainable uptrend.
5. The Dollar and Commodity Markets
- A sharp strengthening of the dollar and rising oil/gas prices put pressure on corporations and consumption. In this case, stock growth will quickly stall.
6. Insider Behavior
- Massive insider selling by top managers at record prices often signals that those at the top do not believe in continued growth.
On a Final Note
Short-term growth amid a weak economy is sustained by expectations of soft monetary policy, improved demand, and strong technology sectors.
A downward reversal occurs when expectations are not met: inflation stalls, the Fed does not cut rates, corporate reports deteriorate, and real macro data becomes too negative to ignore.
This can be spotted in time through “warning signs”:
- deteriorating corporate expectations;,
- divergence between stocks and bonds;
- a decline in market breadth;
- increased volatility and hedging;
- movements in the dollar and commodities.