The debate as to whether stock markets can predict the upcoming economy is one that is ongoing but one thing is for sure – trends and movement within stocks can have a profound impact on how traders and customers operate within the global economy regardless. Momentous stock market crashes can have a profound effect on the economy as we know it, but with the stock market not being classed as the ‘real economy’, could smaller movements really have an effect? Below, we’re exploring how the trends in major stock markets can have an effect on the global economy as we know it.
What Is The Stock Market?
For those that aren’t already aware, the stock market is a place in which shares of public listed companies are traded. Essentially, stocks are units of ownership of a company and investors typically buy these stocks at a reasonable price in the hope that they can get a profit for it in the future. The typical length for which investors are advised to hold onto stocks is around 15 years if they hope to succeed in markets and so traders should arguably be in it for the long-term. Of course, for industries that are skyrocketing, this time could be much shorter, but this is rare and quite a high risk to take.
In general, businesses that invest in stock markets are investing in their future and can go on to sell stocks for a number of reasons. Whether they use it as a source of money for hiring new employees, expanding their business abroad or simply to a larger building or even improving their business activity, stocks can provide a simple source without needing to take out a loan. The selling of stocks can even fund new products and improved research, and so it’s easy to see why most companies look to invest in stocks where possible.
How Do Stocks Affect The Economy?
Stock markets are typically hosted by a stock exchange and while markets themselves may not necessarily have an effect on the economy, the activity of these major stock exchanges certainly can. Take the New York Stock Exchange, for example. This exchange was one of the first in the world, and has since grown to incredible size and strength. Today’s New York Stock Exchange (NYSE) is home to some of the largest markets, including the New York Stock Exchange, Arca, MKT and Amex Options, with leading companies such as the Ford Motor Company, the Bank of America, Pfizer and even Twitter listed amongst the companies open for stock trading.
Major stock exchanges have the potential to influence the economy, not just in their country of origin, but globally. Essentially, the state of markets within these exchanged can discourage and influence investors across the globe to invest more or less, depending on the potential wins or losses they could experience. Because of this, there could be more or less money circulating at any one time and ultimately affecting the overall economy.
Beyond just investor behaviour, however, the markets can affect pensions, business successes, bond markets and more. Let’s take pensions as an example – when the stock markets are struggling, private pensions or investment trusts can be affected, especially when there is a prolonged fall. As a result, pensions can lose their worth and with more and more people building up an emergency fund as a result, there will be even less money circulating and a weaker economy as a result.
Companies that have invested in stocks as a form of future finance can also contribute to a weakened or ‘stalemate’ economy. When stocks fall, companies are less likely to make further investments or sell what they have, and so the markets and the companies themselves hit a stalemate. Once again, this prevents industry growth, money circulation and even has an effect on overall confidence which is all too often reflected in the overall economy.
How Does The Economy Affect The Stock Markets?
Of course, like some stock markets could affect the economy, the economy can have an effect on the stock markets. Everything from inflation and differing interest rates, to the activity of foreign markets can affect how the stock markets are performing, which we’ve delved deeper into here:
- Inflation and Deflation
The changing prices of goods and services can, of course, affect the prices of stocks within the market. Changing economic trends can send prices soaring or plummeting and this can change how a market is performing. Investors tend to lean towards better value investments and if prices are inexcusably high, a market is less likely to be active.
- Interest Rates
Banks can have an effect on stock markets and as a result, the interest rates they’re charging at any one time can also affect its activity. Higher interest rates make money much more expensive to borrow, and as a result, companies need to change how they do day-to-day business. As a result, the stock markets are likely to drop, as these companies are unlikely to be spending, could be laying off workers and will probably avoid borrowing as much as usual.
- Foreign Markets
This is particularly important when considering the US stock market, but foreign markets can change how US stock markets are performing at any one time. When economies are struggling abroad, companies struggle to sell products and exchanges struggle to sell stocks as a result. Similarly, when major foreign markets are doing well, US markets benefit considerably and the overall global economy starts to look up.
The effect of stock market trends on the global economy ultimately depends on the size of the market, how long the trend goes on for and the state of the economy prior to the trend. Major exchanges like the NYSE can affect how confident people are in their financial decisions, and with limited investments, the economy can hit a standstill or start to plummet. In short, while stock markets themselves might not have a direct effect on the economy, how investors and traders react to these stock trends certainly can.