When we put the stock market and economic growth in the same discussion, it usually centers around how GDP affects stock performances. This is the more direct correlation between the two, as GDP sheds a general light on how the economy performs and gives everyone an idea of whether it is safe to invest in company shares or not.
However, we are here for the less-discussed relationship between the two. The stock market breeds sentiments and these sentiments, in turn, affect how the general economy and specific sectors of it are looked at. While studying how to trade stock, it’s important you know the relationship between the two.
Our article explores how these stock market performances and sentiments impact economic growth, including information on the separate results of different market conditions. Let’s get into it.
Establishing Relationship Between GDP and Stock Market
The major indicator of economic growth is the Gross Domestic Product (GDP), which represents the value of all the goods and services produced in a country within the period in review. The change in GDP equally represents the change in economic growth, which could be either a rise or fall.
Now, GDP is majorly determined by how much money is spent on production within the economy. In the same light, there are four categories of entities who spend or put money into the economy for the production of these goods and services; consumers, businesses, the government, and export.
Consumer spending looks at the domestic end-users that purchase finished goods and services. Government spending includes what the government expends to facilitate production and purchase, while exports relate to spending by foreign consumers.
All these particularly center around business revenue generation and spending, and this is where the stock market takes effect. Business spending or capital expenditure connotes what companies spend on maintaining or improving capital assets and operational costs, such as expenditure on buildings, equipment, and staff, among others.
The Stock Market And Business Spending
The condition of the stock market is mirrored by the health of companies operating within it. Companies are businesses, and their health refers to factors around their launch, operations, and revenue generation.
All of these cause a rise or fall in share prices, which affects the sentiment in investors on whether to spend more on the company or pull out of it. The decision here causes increased or reduced business spending and ultimately affects GDP.
During lessons on how to trade stock, as in any other market, we learn we either have a bullish stock market or a bearish stock market. Each of these has its separate implications within the sequence of cause and effect we have laid out.
Impact of Bullish Stock Market Conditions on GDP
A bullish market is a condition where company stock prices are on a rise or expected to be on the rise. Of course, this is caused by the optimal health of most companies within the market, thanks to increased revenue generation, reduced debt, and hitch-free operations.
Bullish markets invoke positive sentiment in both domestic and foreign investors. Investors buy more shares, which means more capital funding for companies to spend on growing through improving production assets, technologies, and hiring.
More business spending leads to greater GDP, and we have positive economic growth. What’s more, consumer confidence also increases thanks to initial GDP growth, leading to more consumer spending and even more GDP generation.
Companies even have the confidence to release more shares, have more investors buy the shares, and generate more capital for their business spending. All other factors being equal, a bullish stock market then leads to positive economic growth.
Impact of Bearish Stock Market Conditions on GDP
Compared to a bullish market, a bearish market is where company stock prices are falling or expected to fall. This is a result of most companies experiencing reduced revenue generation, increasing debt, and general doubt about the strength of their operations.
All these negative factors cause negative sentiments in investors, and these investors either stop buying shares or even take out their previous investments by selling the existing shares they have. Companies lose funding and reduce spending to stay above water.
As we have mentioned, reduced business spending leads to reduced GDP generation. Consumer confidence is additionally affected, leading to reduced consumer spending, which bears a further hit on the country’s GDP. A bearish stock market can then be said to cause reduced or negative economic growth, with all other things being equal.
Disclaimers On Impact Of Stock Market
Our mention of “all other things being equal” isn’t just a play on words but a very purposeful addition. Understand that GDP affects more than just company spending or even bare economic performance.
Political and dire environmental factors may negatively affect GDP generation even when the stock market is consistently bullish. All these have to be on a neutral or equally positive (or negative) ground for us to expect the stock market condition to impact economic growth directly.
There’s even more when learning this and how to trade stock. GDP affects the stock market on a greater scale than the stock market affects economic growth.
GDP Has More Effect On The Stock Market
The factors affecting GDP have more scope than just the stock market or business spending. When economic, political, or environmental factors affect the economic growth of a country, consumer confidence reduces, which means less consumer spending, less business revenue generation, and increased debt.
All these negatively impact sentiments in investors as stock prices start to dwindle. Investors then pull funding out of company shares, negatively impacting these stock prices and the overall stock market. Bad economic growth can potentially turn a bullish market into a bearish one than the stock market in switching up the economy.
Conclusion
To sum it all up, the impact of the stock market on economic growth all depends on the sentiments created in investors and how much more capital expenditure businesses get to spend to produce goods and services.
A bullish market has a positive impact on economic growth and a bearish market harms economic growth, with all other factors affecting GDP needing to be equal. Knowledge of this is also important in learning how to trade stock.
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