Over the years, the bond between the stock market and the economy has become stronger. A slight alteration in the stock market levels bears the impact of either stimulating investor confidence of causing panic, resulting in either injection or withdrawal of investment in the market. Most people would therefore argue that a boom in the stock market directly implies economic positivity, however, this is not always the case.
To begin with, the stock market is highly volatile, meaning that, it is subject to fluctuations at very high rates. Since most people use the stock market as the mirror to a nation’s economy, a boom in the stock market would trigger investments from not only external sources but also internal ones such as personal wealth investors, pension fund companies and other players. Additionally, due to the boom, consumer activity may increase as most people are confident with the economy hence high expenditure and low savings. Therefore, in case of slight panic in the stock market environment, a collapse can occur quicker than these parties can withdraw their investment.
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The resulting effect would be catastrophic to a nation’s economy. Companies would reduce employee benefits such as healthcare plans in order to recover. People would face financial constraints as financial institutions would deny them loans due to low savings, hence a drop-in living standard. Additionally, employment levels would decrease since companies, whose equities were heavily invested in the stock market would suffer from low stock prices and high liquidity rates by their investors. As a result, these companies would luck operational funds to even sustain the existing employees. The overall impact would be economic turmoil, as personal incomes would be lost and investors would be scared away, resulting in low GDP and per capita. A classic example of this phenomenon is the 1929 stock market crash that had been preceded by a boom, creating a trading bull market perception.
Responses
To First Student
In concurrence, a number of people, especially in these modern times have become more and more inclined towards the ‘status quo’ aspect of investment. People have grown accustomed to blindly injecting investment to the stock market without apposite consideration of the Return on Investment or even proper background research. It is not uncommon to find someone betting on a company’s stock market performance based on the net worth of its owners or even popularity. Blame this on the poor financial management education and the ‘get rich quick’ attitude possessed by many modern-day individuals. As a result, the stock market may gain high financial investment from multiple uninformed people thus creating a fake perception that the economy is booming. One can only predict how much money the masses would lose in case the stock values fluctuate by a significant margin; leading to loss if income, investments, and possibly people’s livelihood.
To Second Student
In addition to the point raised, the mass selling of stock also bears an increased money supply effect to the economy. Owed to the high liquidation rate, the economy would be injected with a lot of money which may not necessarily correspond to its goods production rates. This would result in a lot of money chasing few/limited goods, resulting to inflation. It is therefore important for people to understand that a nation’s economy is not as flexible as the stock market. The economy grows of drops by a rate that may take years, decades even, to appear significant. Therefore, as people invest in stock, it is important to have a liquidity plan and know when to dispose of their stock. Additionally, regulatory authorities should set a reasonable limit to the value of stock that should be disposed of when selling point is achieved. This limit should be aligned with a nation’s GDP in order to avoid a significant disparity between money supply and the output rates for goods and services.
