The US stock market is enormous. At over $30 trillion, it is a massive one. Many global companies are active on it and they affect the economy as a whole. Pundits have always based their economic forecasts on the performance of the stock market.
The general mood of investors in the market can indicate how the economy will perform in the coming months. The stock market and the economy are thus tied in a special relationship where occurrences on one end affect the end. The following is a breakdown of the key ways in which it affects the economy.
The Working Mechanism of the US Stock Market
Before delving into the key details, it is important to note the mechanisms that characterize the US stock market. To start with, it is among the most liberal ones in the world. It is also huge and it constantly attracts investors from all over the world. The easy processes involved in doing business are the key drivers of investment in the market. Over 46% of households in the US own some form of stocks. US companies are thus enticed by the market and they often get listed when they want to achieve growth.
How the Market Affects the Economy
In terms of its characteristics and contribution to the economy, the stock market is influential in the following main ways. First, it allows the participation of all individuals. Individual investors and private equity investors can all find their space in it. This is one of the best destinations for individual investors since they can bet on their stocks to give them returns. Representing 40% of the global stock market cap, in the US, it is irresistible. Information is also not a challenge as investors can see the best shares to buy from market data. According to traders working with AdmiralMarkets, investment in this market is also a great way to avoid inflation. When cash is exchanged for shares, the value is retained regardless of the prevailing inflation.
Second, the economy is kept vibrant because of the stock market. When companies are looking for capital, they turn to individual investors. They do this by floating an IPO where anyone can buy shares in the company. This means of raising capital is effective because it gives investors the confidence to buy shares knowing that the firm is valuable enough to go public. Shareholders who buy stocks maintain percentage ownership of the company and thus become invested in its success. Most IPOs end up raising a large capital and this has a lot of bearing on the company.
Lastly, the behavior of investors in the stock market indicates how they generally feel about a particular company. When the stock prices of a particular company go up, the indication is that investors feel confident about the future of the company. When the prices are falling, it means that investors are not confident in the company’s ability to generate profit. These occurrences have an effect on the economy as a whole. In recent times, the technology sector has become the largest in the stock market, accounting for 26% of the total value.
The Effect of the Economy on the Stock Market
As noted earlier, the economy also affects the stock market. It is a major source of insights for various entities in the economy. When the economy is fairing well, more consumers are likely to increase their spending. One of the areas where consumers end up spending their extra cash is on investments in the stock market. The demand for goods and personal consumption are thus crucial factors that affect the performance of stocks in the market. The various indices show how it performs throughout a business cycle. In a given period where the GDP is faring well, a good performance will be recorded on the stock market and vice versa.
Effects of the Stock Market are Limited
To conclude, it is important to note that the stock market is not the same as the economy. Even in the US economy where the exchange is huge, the economy is big and independent enough to function under its forces. Investors in the stock market might sometimes fail to read the signals of the economy and end up overinvesting, leading to a crash.