Up until now, you have heard of the impact of economy, global events, and news in the stock market but have you heard of the impact of stock market volatility on an economy? – You have probably not. In any case, we are here to help you understand: How the stock market affects the economy of a country. With this article, we aim to answer the same and discuss the impact of rising and falling stock market on the economy.
Let us get started!
A stock market is a place where an individual can buy or sell the stock or other security that represents his/her ownership in a company or organization. The market exists for two main reasons:
- To help companies in raising capital to further use to expand and grow businesses and,
- To provide investors with the opportunity to earn profits on buying and selling of such assets.
A stock market is a place for an individual for wealth creation over the period. That is why it attracts masses to invest their savings and make the most rewarding investments. Therefore, that brings us to the question:
How these stock prices are determined
Well, the stock prices depend upon the force of demand and supply. A continuous rise in price called uptrend while the continuous fall in price called a downtrend. If the uptrend sustained, it is called a bull market and ‘bear market’ in case of a sustained downtrend.
This increase and decrease in the stock prices can influence many factors in the economy, which in turn have a positive or negative impact on the economy as a whole. Alternatively, certain economic conditions can affect the stock market as well.
How Stock Market Affects the Economy of a Country?
Here are the few ways a stock market affects an economy:
Movement in the Stock Prices
The volatility in the market is due to the movement in stock prices. As the stock prices move up and down, the volatility in the market can have a positive and negative impact on the consumers and businesses. Demand and supply of a company are heavily influenced by the underlying business. If the business is doing well, the business will attract more investors towards it. The increased demand will bid up the prices of the stock to entice sellers to sell. As a result, the stock price increases. If it sustained for a while, the bulls will dominate the market. When the bulls run, the economy will boost too.
However, if the underlying business is not performing well, the investors will lose their interest in the falling price of the stock. This will lead to sellers to bid down the prices to entice the buyers to buy, therefore increasing supply. Excessive supply will affect the business. If it sustained, the market will be under the control of the bear, leaving a negative impact on the economy.
When the stock prices rise and bull controls the market, the investors are more confident in the market conditions and encouraged to invest more in the market. More they invest and receive returns, more their purchasing power increase. Consequently, they buy expensive items, plan holidays etc. When they do not, only they spend money but also contribute to companies’ growth. The increase in sales generates higher revenues for companies, which led to a positive influence on the economy.
Similarly, when the market is under the control of bears, the investors feel discouraged and avoid making investments in the market, which led to profit booking. When that happens a large chunk of amount outflowed from the market, which left many companies vulnerable to the excessive outflow. When that happens, the investors avoid making investments and move towards fixed income instruments such as debt securities, fixed deposits, and government bonds. When that happens, the companies witness the steep fall in their sales and growth, which put a negative impact on the economy.
Apart from consumer spending, business investment is also a key factor that contributes to economic performance. When the stock prices skyrocket, many companies issue an IPO during the bull market as the optimism is high and it is a good time to generate capital through issuing IPO shares to the ‘general public’. In fact, there are more mergers and acquisition deals during this period. The more capital inflows in the market, more economy performs.
However, when the market is under the control of bears, there is an opposite effect on the economy. Investors’ confidence goes down and the businesses are no longer eager to invest in the economy. The steep loss in the stock prices makes companies avoid using capital to further expand or indulge in IPO or merger deals.
Stock market and economy are two entirely different things. The stock market is one of the factors that affect the economy. There are other thousands of factors that affect the economy that can have a positive or negative impact.