Understanding the impact of stock markets in the USA, we will first need to understand the underlying factors about the stock market itself.
When someone buys a share of a company, a part of the company is owned by that person. The stock market’s everyday moves are based on the optimism of the market participants, although stocks with good fundamentals tend to provide handsome returns in the long run. The best performing stocks in the market will always help the overall economy.
Why is the stock market attractive to investors?
The US stock market is easier to analyze. Companies find it easy and convenient to get listed on the markets. Investors have access to a lot of information about the market and help them remain confident with their investment decisions. The US stock markets also provide investors with the option to invest in multiple instruments like equity shares, equity-linked mutual funds, and stock options.
How does the stock market influence the economy?
There are primarily three ways in which the US economy is influenced by the stock market. These are:
- The stock market provides the smallest of investors an opportunity to gain from the booming free economy of the US. It is to be noted that without a stock market, only big institutional investors like large private equity investors and financial institutions could get the opportunity to invest in the companies listed on the market.
- The stock market has been known to provide immunity from inflation. Yes, on average, the stock market has grown by 7% after adjusting inflation. This is a very handsome return on investment for most investors. Many investors enjoy this as a hedge against inflation for their money. The earnings that an investor can earn from the stock market do come with risks. However, the returns motivate most investors to put a part of their money in the stock market to beat inflation.
- Stock markets are the go-to place for companies when they need funds for growth. The procedure involves selling off a part of the company as an IPO (Initial Public Offering) in the stock market. The IPO catches the eye of many investors, and generally, IPOs tend to be oversubscribed. The company generates a lot of cash through this process, and the investors get to know that the company is financially strong enough to go through the IPO process. The IPO, however, means that the founders no longer wholly own the company. The founders can control the company by having 51% of the shares, making them the majority shareholders.
The movements of stocks (fundamentals VS market belief)
Indices like the DJIA, S&P 500, etc., tell us how the market is performing. These indices are a collection of many proven stocks. The market moves on belief in the short term. Investors believe that the shares of a company may be good and have good opportunities for earning. These stocks move higher. When the investors feel that a company may not improve profit or sustain its performance, the belief is lost. These shares start plummeting. The market belief moves the prices on a short-term basis, and people can earn from these movements by entering and exiting trades for a short term. Fundamentals of a company, however, helps it stay immune to these short-term sentimental moves. Yes, a company with reliable fundamentals experiences fluctuations in its share prices owing to market belief, but in the long term, it continues to grow.
Stock market crash and its implications
As discussed earlier, the stock market is driven by sentiments. Sometimes the investors start fearing too much growth. Also, other factors like certain financial news, war, pandemics, etc., can cause investors to lose their optimism. This results in the dumping of shares in the market resulting in a dip in the prices. This is called a stock market crash. The result can be very detrimental for the economy if it continues for a considerable period. The wealth of investors get depleted. Companies will not have funds to grow, old employees close to retirement may not have enough money to retire, and many other problems develop due to stock market crashes.
Overall, it is understandable that though the stock market is not the only thing that impacts the US economy, it does have a vital say in its performance.
Disclaimer: This content does not necessarily represent the views of IWB.