The notion that the stock market isn’t the economy just doesn’t hold up anymore
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Wall Street station, near New York Stock Exchange, New York. Monday, January 3, 2022.
Bloomberg | Bloomberg | Getty Images
While the stock market might not be considered the economic, the difference between them is becoming more difficult to make.
With household ownership of stocks scaling new heights and the destiny of companies — particularly in the innovative tech sector — tied to their share prices, the fates of Wall Street and Main Street have never been so intertwined.
As the stock market goes through this volatile periodHowever, this is not an encouraging sign for the overall growth outlook.
Joseph LaVorgna is chief economist for Americas, Natixis. He said, “In the 20 years since then, our financial economy has grown substantially.” One could have said a decade ago that the stockmarket was not an economy. That was very true. This is not true today.
Although it would be hard to argue that the stock markets are all economic, it can also be difficult to contest the fact that they have become more integral part of our daily lives.
According to the Federal Reserve data, 41.9% of households’ wealth came from stocks directly and indirectly through 2021. This is more than twice the amount it was thirty years ago. The United States has become a popular place for investors to save money and get nice returns due to many factors.
This has also made Wall Street more vulnerable to economic shocks.
LaVorgna said that “when risk assets drop and fall quickly enough, there is no doubt they’re going to affect growth.” He was also the Chief Economist for the National Economic Council, which was headed by former President Donald Trump. The relationship between asset prices and growth is actually better when they fall than when they rise.
It works
While the mechanism of economic growth and market activity is complex, it’s relatively simple.
In the past, stocks and consumer confidence were closely connected. As a result, when stocks drop people tend to reduce spending. This decrease in spending leads to slower sales growth which, in turn, makes share prices less appealing when compared to future earnings. This triggers a market response that results in less wealth being reflected on consumers’ balance sheets.
A second important aspect is also worth mentioning: Silicon Valley companies are known for their innovation and need to constantly raise capital.
“In addition, the wealth effect on consumers is also important.” [the market]Investment decisions of companies can be affected, particularly high-growth businesses, tech companies who rely on capital raising through the equity markets to finance their growth,” stated Mark Zandi chief economist at Moody’s Analytics.
It’s more challenging to raise equity if stock prices fall. He added that their capital cost is much higher so they won’t be able expand as aggressively. That’s just one element in the relationship between the growth of economic growth and the stock market.
When revenue growth slows enough, businesses must then find a cost-saving solution to increase their bottom line.
They usually start with payrolls.
Employment has been rising at a steady paceThese two years were a good example of the changes that have occurred in the stock market. However, this can be ended if current turmoil continues.
Quincy Krosby (chief equity strategist, LPL Financial) stated that companies manage share price. They will reduce costs if necessary. Labor is the main expense of capital for most businesses. This is another reason the Fed must be vigilant.”
What the Fed does not fit in
The Federal Reserve, in fact, is an important component of the economic link between markets and economy.
Although central bankers have always been attuned for market movements, after the 2008 financial crisis, monetary policies now heavily rely on risk assets to transmit information. In an attempt to maintain low rates and keep cash flowing through the economy (including the financial one), the Fed has purchased more than $8 trillion worth of bonds.
Steve Blitz (chief U.S. economist, TS Lombard) stated that “consumers are extraordinarily engaged in the equity market and the Fed have put them there.” In particular, since 2016, the majority of consumers have bought equities. The correlation between equity price and discretionary spending has been very strong.
However, Fed officials might be happy to see some Wall Street froth.
Inflation is still the main concern for the central bank. It has resulted from a shortage of goods and services, which in turn has led to a steady increase in consumer demand. Since Thursday the day following the election, markets have fallen into a sell-off cycle. Fed announced a 50-basis-point rate increaseThis was the largest increase in 22 years.
Additionally, the Fed is set to begin shedding some of its bonds. Another process that affects Wall Street directly but also impacts Main Street through higher borrowing cost, especially for home loans.
Krosby explained that the economy and market “are distinct, but are connected at certain points.” Market “is part of financial conditions and when the market pulls back it will help curb demand. This is what they desire. They wish to slow down economic growth.
Still, Zandi, the Moody’s economist, cautions against letting the current downturn in which the S&P 500 has tumbled about 15% year to date to send too strong a signal about a recession ahead.
GDP dropped at a 1.4% paceWall Street economists saw stronger growth during the first quarter. However, they expect more to come through the year.
Zandi explained that although the market provides a reliable indicator about where the economy will be headed, it can also overstate the situation. So the market selloff is strongly in favor of a slower growing economy. Perhaps it’s even flirting with recession. It’s likely getting ahead of it in this regard.
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