Working of the Stock Market and the Economy
The financial market is often referred to as an economic indicator of the economy. As we know, the business confidence of consumers and their expenditures are a major pull factor of the economy. It’s a common belief in the financial market that a boom in the stock market is an indication of a progressive economy. With the improvisation in the economy, the companies make more money which results in an increase in stock prices. On the other hand, a burst in the stock market bubble is an opposite scenario. This occurs due to a significant decline in the confidence and spendings of the consumers which can be due to factors such as an increase in oil prices, high interest rates, inflation, etc. A slower or weaker economy results in fewer profits for the company, lower future earnings and more unemployment which further cause the stock prices to fall. In reality, the only force which affects the stock market or any other market, in the long run, is the volume of total expenditure in the economy. The process of stock rising is caused due to the inflation which sums up to more money in the markets and hence in the economy.
The most important relationship between the stock market and the economy is the very fact that a high in credit and money will push GDP and the stock market together. When we talk about a progressing economy, it is the one in which goods are produced regularly. These goods refer to cars, refrigerators, clothes, medicines and food which are treated as real wealth. So, if goods are produced faster in an economy, the prices of commodities will fall because the supply of goods increases but the supply of workers doesn’t. If we consider a different scenario where the prices rise due to money being created faster than goods, prices still FALL as wages rise quickly than prices. In both situations, if the output and product are increasing, goods get cheaper in reality. In other words, a growing economy will have prices falling and not rising. Doesn’t matter how many goods are produced, if the amount of money remains constant, the only money that can be spent in an economy is the existent quantity in it. This information is enough to understand that GDP does not necessarily reflect the original number of goods and services being produced and it also tells us that a rise in the GDP is due to the increased money supply.
If there were a regular supply of money in the economy, the total amount of all shares of all stocks, combined together, could not increase. In an economy, if the amount of money was constant, the level of stock would stay even or might fall slightly, depending on the rate of increase in the number of new shares issued. Businesses would be selling a greater volume of goods at lower prices, which will keep the value of total profit the same. In a similar manner, businesses would purchase more goods at lower prices each year, keeping the growth between costs and revenues approximately the same, which would further help in keeping aggregate profits similar. Keeping in mind situations like these, capital gains, which is gaining profit after buying assets at low prices and selling off at high prices, can be made only through stock picking. The term stock picking is used to refer the investment in businesses with expanding market share. Through, stock picking, more revenue can be generated at the cost of those firms which are less efficient and innovative companies. The value of a stock of the profit earning companies would rise while that of others will fall. Further, the average stock value would not increase and the gains obtained by the investors would be in the form of dividend payments.
In the end, we’ve seen that neither GDP nor the stock market can rise without the aid of a money push. Saying this, it is easy to state that a progressing economy neither consists of an increasing GDP nor does it causes the overall stock market to rise.