Is it possible for the stock market to rise in value at a greater rate than the economy?

Question

Surely the economy is the sum of all the money changing hands in the country and the activity of all the companies.
I don't understand how the economy can be growing at a fw percentage points but the stock market in general grows at a faster rate than this.

Answer 1

Yes. You seem to be thinking only of GDP and completely forgetting the capital stock...

For example, at the beginning of fiscal 2006, the total capital stock in the U.S. economy (at current cost, including residential buildings) was about $30 trillion. During fiscal 2006, that capital stock earned about $2.8 trillion in interest, dividends, rents, and proprietors' income. So overall, the U.S. economy earned a 9.3% return on investment. Since creditors consistently earn less than that (after adjusting for defaults), stockholders must earn more (in the long-run, anyway). The reality concurs; in the long-run, the U.S. stock market delivers approximately 12% per annum, of which approximately 2% come as dividends with the remaining 10% being capital gains (or, in your terms, the "rise in value").

Answer 2

Stocks are the rights to the profits stream of companies which rise more or less in line with GDP growth. But the price of stocks varies not only with profits but with interest rates because investors choose among the investment alternatives balancing risk and return. see
http://en.wikipedia.org/wiki/Capital_asset_pricing_model
A recent study estimate that about 1/3 of the of the increase since 1980 has been due to the effect of the decline in interest rates. Since rates are now relatively low it is unlikely the stock prices will rise as much in the next 30 years as they have over the last 30.

Answer 3

Because markets are not always efficient. Psychology can be pushing stock prices higher ("irrational exuberance") if people expect profit growth to accelerate. Momentum investors then push the markets even higher and P/Es'(price/earnings ratios) get more and more disconnected from reality.

Then there is the problem of nominal versus real returns. If inflation pushes stock prices up it only looks like the market is growing faster than the economy. In real terms, stocks could be shrinking.