It’s common to hear the stock market referred to as a leading economic indicator. The stock market, like most other free markets, is driven by supply and demand. However, what makes the share prices of individual stocks “forward-looking” is that market demand for shares of a stock is not driven by an imminent market need.

A large part of the demand for commodities such as coal, oil and soybeans comes directly from economic needs for those commodities. On the other hand, if the world collectively decided that stocks are no longer worth the investment, demand for stocks would immediately go to zero and markets around the globe would crash.

Perception is reality
Nobel Laureate Robert Shiller is one of many economists that has written about the huge role that psychology plays in the stock market. Wild swings in share prices and market booms and busts sometimes have very little to do with underlying market fundamentals and much more to do with investor sentiment.

The stock market is forward-looking because demand for stocks is driven by investors’ future expectations for a particular company. If an investor believes that a company that is currently generating $10 million in annual profits will be generating $1 billion in annual profits within two years, will he or she invest in the company now or wait two years to do so?

Value traps
The result of the forward-looking nature of stock markets is…

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