Investors care about economic conditions because they influence markets. Economists care about markets because they offer real-time signals about the economy’s health.
Still, it’s essential to remember that the economy and the stock market are not the same thing. That distinction is especially important today, as current policies appear to be widening the gap between the two.
Consider the U.S. stock market. The S&P 500 Index is up almost 10% year to date (a significant rise but a bumpy ride, given the roughly 20% drawdown in April). Yet this performance may obscure important realities about the broader U.S. economic situation. Real consumer spending grew at a 1% annualized pace in the first half of 2025, down sharply from the 4% annualized pace in the second half of 2024, according to the U.S. Bureau of Economic Analysis (BEA). Real GDP growth has been slowing – it grew at a 1.2% annualized pace in the first half of 2025 – down from the 2.7% in the second half of 2024, the BEA reported. U.S. employment growth has decelerated to below 1% so far in 2025, according to the Bureau of Labor Statistics, a threshold that has historically preceded recessions.
Given these metrics, it’s not surprising that a Bloomberg survey of economists puts the average probability of a U.S. recession over the next year at 35% – well above the standard probability (based on the unconditional historical frequency of recessions) of around 15%. However, if someone’s only source of information about the U.S. economy were the performance of the S&P 500, they might see little obvious recession risk.
Why is the U.S. equity market seemingly so disconnected from the real economy? Our analysis suggests it’s a function of three factors: measurement, policy, and composition.
Measurement matters
Economic performance tends to be gauged in “real” (inflation-adjusted) terms, while equity markets tend to reflect nominal sales and earnings per share (EPS) growth. In contrast to the much slower 1.2% annualized pace of real GDP growth, nominal GDP growth was 4.1% annualized in the first half of 2025. That’s much closer to the 4.4% growth in nominal sales per share of the S&P 500, but still well under the 14% annualized rise in aggregate S&P EPS in the first half of the year, according to S&P Global.
Policy impacts vary
Recent policy changes under the second Trump administration – affecting trade, taxation, and immigration – affect S&P 500 companies differently than they do the thousands of mostly smaller companies across the broader U.S. economy.
Why is this? S&P companies, and especially the major players (including big technology firms), tend to be larger and more capital-intensive and may stand to benefit more from the recently extended business tax cuts and generous investment incentives. They are likely better positioned to weather and absorb tariff-related costs through business diversification and market share gains. This divide shows in market performance: The S&P 500 is up almost 10% year to date, while the Russell 2000, which tracks smaller firms, is only up about 3%.
Industry estimates suggest the aggregate impact of higher tariffs on S&P companies is likely to be offset by other tax savings. In contrast, data from Congress’ Joint Committee on Taxation and the U.S. Treasury suggest that the net effect of the tax and trade policies in 2025 will be higher government revenues in 2026 – assuming the policies continue.
The depreciation of the U.S. dollar since the beginning of the year also favors larger multinationals. The top seven companies generate nearly 50% of their sales outside of the U.S., compared with 28% for the S&P overall. Even the bottom 400 S&P companies average nearly a quarter of their revenue from international sales. By contrast, U.S. exports account for around 10% of U.S. GDP, according to the BEA and S&P Global.
Composition: What’s driving much of S&P 500 performance?
Much of the S&P’s YTD gains stem from companies tied to the AI and digital transformation cycle. Technology has also contributed to real GDP growth. However, tech’s contribution to the overall economy is still much less than its contribution to stock market gains. The information sector accounted for only about 5.4% of total U.S. GDP in the first quarter, yet represents about 40% of the S&P’s market capitalization, according to the BEA and S&P Global.
In the U.S. labor market, these compositional differences are magnified. Bloomberg data suggests that hyperscalers – companies that operate large data centers for AI and cloud computing – and chip providers account for less than 2% of U.S. employment, despite comprising roughly 35% of the S&P’s value.
That said, we acknowledge that investment related to digital transformation is boosting U.S. GDP. We estimate that spending on computer equipment, software, and R&D contributed around 1 percentage point to annualized real GDP growth in the first half of 2025. Without it, growth would have been closer to flat. Capital expenditures will likely remain elevated as companies race to meet expected AI demand. However, if adoption slows, so will these trends. Outside of AI, capital spending has been sluggish.
Takeaways for the broader outlook
While S&P 500 revenue and earnings trends are partly rooted in U.S. economic activity, they may not closely reflect the broader economy. Policy changes and the AI wave have created winners and losers. Large, capital-intensive companies with relatively little direct exposure to higher tariffs – such as tech companies – stand to benefit most. These companies represent a small share of the U.S. economy but are driving outsize market gains. In contrast, economic and market performance in more labor-intensive sectors and among consumers has been lackluster.
How long this disconnect continues – and how it resolves – will be important. If productivity gains from broader AI implementation are realized, perhaps they could lift the economy and help justify stock performance. However, over the next few quarters, with policy uncertainty and tariff-related price adjustments likely to weigh on real incomes, consumer spending, and broader investment, markets appear increasingly dependent on the technology revolution continuing to play out. Without it, the market risks reconnecting with the current, more stagnant economic reality.
By Tiffany Wilding, PIMCO Economist
