Why Stocks Are RISING While the Economy Is STRUGGLING? (European Investor)

Added: 2026-05-14

[00:00:00]Have you ever looked at the stock market and thought, "How can stocks keep climbing?" You read news about the Iran war, high inflation, tariffs, and government deep in debt. As economic growth slows down, shouldn't stock investing begin to fail? The S&P 500 rose 24%, 23%, and 16% in the past 3 years, it's been hitting one all-time high after another. In the meantime, global GDP, the size of the world economy, grew only 3% per year in real terms. And just a few decades ago, it was growing four to 5% per year, much faster. So, what is going on here? How long can stocks keep going up and up?

[00:00:39]Well, I'm Tom Crossell. I've got 18 years of professional investing experience both on Wall Street and running an investment company here in Europe. And it actually took me more than a decade to fully understand what I'm about to show you. What we're going to do is break down the different reasons why stock prices go up over time. And the first reason is really powerful because it even works if there is zero economic growth. To explain it, here's a thought experiment. Let's say you own a family grocery store in the UK. It's been a stable business for 50 years. You've been selling the same quantities of bread, milk, and butter for decades with no growth. 50 years ago, the annual revenues of this business were £250,000.

[00:01:20]and the annual profit was roughly £10,000. But over the past 50 years, prices have been going up. Bread and milk and sugar, they have all been getting more expensive. So today, the store's annual revenues are 1.7 million.

[00:01:34]Of course, it now also costs more to supply the store and pay your staff, but at the end of the day, your annual profit has also increased to £70,000.

[00:01:44]Not because you're selling more stuff, but because the stuff that you're selling is more expensive because of inflation. And naturally, if you've got a business that's making £70,000 in profits instead of£10,000, the share price of your business also goes up. So, this illustrates the first reason why stock prices go up over time, and it's simply inflation. Of course, this is a simplification, but on average, over the long term, as everything in the economy gets more expensive, company profits go up and stock prices tend to go up as well. Now, some people will tell you this type of price increase is just an illusion. They only care about real increases in stock prices after subtracting inflation. But I don't think that's quite right. Because as investors, we face a very real choice between keeping cash in hand, which will lose value to inflation, and investing your cash in stocks, which will likely protect us from inflation. And that makes a huge difference. Now, as it turns out, there's also a second reason why stocks could keep going up even if we had zero economic growth. Let's go back to our grocery store. Your family have been running this grocery store for 50 years through bad times and good times with all the stress that comes with it. and they haven't quit to get full-time jobs. Why is that? Well, probably because the business has been reliably profitable. The profits haven't grown in real terms, but they have kept up with inflation. So, here's the point many people miss. Zero economic growth does not mean zero profits for companies. Zero economic growth just means you keep the status quo. And in the status quo, the average company is profitable. In the stock market, part of those profits get paid out as dividends or they get returned to investors through share buybacks. Okay? So that ends up as income in your brokerage account and the rest gets reinvested inside the company which is reflected in rising stock prices over time. In other words, stock investing can still give you a real positive return well above inflation even if economic growth is zero. And then we get to the third reason why stocks go up, which is growth. As companies innovate and develop, as their profits rise faster than inflation, this gets reflected in the stock price. At a macroeconomic level, over the long term, GDP growth does factor into stock market growth. If real GDP is growing, that boosts stock returns. And yes, because global GDP growth has become slower over time, that should mean somewhat lower stock profits going forward. That said, this story is actually quite complex because a country's stock market does not reflect the country's economy. Take the US for example. If you look at the S&P 500 today, around a third of total revenues come from foreign countries. This means that if there's strong economic growth in those foreign countries, or if those foreign countries import more and more from America, this is going to boost American stock prices well beyond what you would expect by looking at the US economy. So, the fourth reason that can push up stock prices is international markets. And the complications don't end there. America today has around 33 million different businesses, but less than 5,000 of them are publicly traded on a stock exchange. The S&P 500 is dominated by tech companies and goods producers, while around 2/3 of US household spending is on services. So, this means that public companies traded on the stock market make up only a fraction of the real economy. If the public share of the economy rises over time, if public corporations take away economic share from private companies, then stocks can end up rising faster than overall economic figures would suggest. So that is the fifth reason that can push up stock prices. Rising share of the economy that is attributable to public companies. If you look at these five reasons, hopefully it's no longer surprising to you why over the really long term, stock charts virtually always go up and to the right.

[00:05:46]Why the stock market reaches all-time highs an average of 16 times per year.

[00:05:52]Now, to be clear, yes, the market crashes from time to time, and right now there are real concerns about how expensive stocks are and the AI bubble.

[00:06:00]We'll talk about that in a moment. There can even be decades where the stock market has very poor returns. Okay, but the five reasons we've covered do not explain periods of truly tremendous stock profits. Like the past 15 years where US stocks have gone up 14% per year on average. That is 11% per year after adjusting for inflation, more than double the long-term average. So where is this coming from? Well, there is one last factor that dramatically affects stock returns, especially in the short to intermediate term. The crude way to describe it would be investor hopes and dreams. The formal name would be valuation expansion. Valuation is just a fancy name for how high stock prices are. The most common valuation metric is the price earnings ratio. You'll take the price of a stock, you divide it by the earnings per share, you get the PE ratio. This describes how expensive a stock is compared to how much profits the underlying company is generating.

[00:07:00]When investors become more enthusiastic about future profits, about how fast profits are going to grow, they become willing to pay a higher price for the same level of earnings. For example, as investors get super hyped about AI, they become willing to pay much more for companies like Nvidia, Apple, or Microsoft, even if current financials don't really justify those prices. So, the PE ratio of these stocks shoots into the sky. And that is exactly what has happened in the US stock market. This chart from Barclays shows the average PE ratio in the US stock market over time.

[00:07:35]And we can see that valuations have been shooting up over the past 15 years.

[00:07:39]Today, they are near the highest levels in history, almost as high as during the dotcom bubble of the late 1990s. Almost all of the increase has been driven by these big tech companies. With valuations, what goes up must come down eventually, or at least it must eventually stop going up. You cannot expect investors to pay more and more for $1 of profits forever. But does this mean that we are definitely in a bubble today in 2026? Does this mean that we're headed for a crash? Well, maybe. Market crashes are extremely difficult to predict. All we can say with reasonable certainty is that high valuations are typically associated with lower stock profits going forward. But the thing is this can happen in many different ways.

[00:08:24]You could have a slow grind where valuations stay high for years. So it costs investors a lot of money to buy a stock and because of that we get low dividends and low stock profits for potentially many years in a row. Or you could have an optimistic scenario where AI really is super amazing and company profits grow as rapidly as people hope.

[00:08:47]And then of course you could also have a crash scenario where investors lose hope in the AI revolution. Stock prices fall sharply and valuations compress. That is exactly what happened after the dotcom bubble and it could happen again. Or maybe the inflation shock caused by the Iran conflict devastates the global economy. Which scenario will happen is impossible to predict. As the famous investor Peter Lynch said, more money has been lost in preparing for corrections than in the corrections themselves. So knowing all of this, what should a smart investor do? Well, go back to the basics. Make sure you have a safety cushion. That's uninvested money sitting in the bank for difficult times.

[00:09:27]Check that you're taking the appropriate level of risk for your age. If you're 65 and about to retire, you shouldn't have 100% of your money in stocks. And third, make sure that you're diversified and your portfolio covers many different regions, industries, and stocks. I'm not saying you shouldn't invest in America just because valuations are high. If you are convinced that the AI revolution is real, even a 100% American stock portfolio could be really attractive.

[00:09:53]But you do need to be aware of the risk.

[00:09:55]And here is a piece of good news on that front. If you look at stock markets around the world, for example, if you look at Europe or Canada or Australia or elsewhere, you can see that valuations are much lower than in America. Stocks are not nearly as expensive. So that means that if you diversify your portfolio geographically, at least this valuation risk becomes significantly lower. Now, as a practical matter, the easiest way to diversify your portfolio is through ETFs and index funds. With just a few clicks, you can invest in hundreds of stocks across many different countries. But for beginning investors here in Europe, ETFs can be tricky. You will have many questions like which ETF should you choose? What brokerage or investment app can you trust? when is a good time to start and how do you handle taxes? I run a step-by-step training program for beginning European investors called the index masterass where I show you how to figure all of this out. It has over 8,000 members in 36 European countries and honestly, I think it's pretty wonderful. So, if you'd like to find out more, just follow the first link in the description.