Something needs to be done to fix the system. It is no longer a secret that stock markets behave like casinos. Stock prices move up or down mainly due to investors’ sentiments than the performance of the economy.
The report indicates that contrary to conventional wisdom, and what may be a surprise to those who see low single-digit rates of gross domestic product (GDP) growth as incompatible with solid double-digit stock market gains, GDP does not have to be booming to produce solid gains in the stock market — as 2013 can attest. In fact, there is little relationship between the magnitude of GDP growth and stock market performance.
There are many examples to confirm the findings of the report. Sometimes stock prices increase before the economy enters into recession and decrease before the economy expands.
But despite the relatively weak influence of the economy on the stock market, the impact of the stock market on the economy might be significant.
The stock market affects gross domestic product (GDP) primarily by influencing financial conditions and consumer confidence.
When stocks are in a bull market, it boosts optimism surrounding the economy and the prospects of various stocks. High valuations allow companies to borrow more money at cheaper rates, allowing them to expand operations, invest in new projects, and hire more workers.
All of these activities boost GDP, consumers are likely to spend more and make major purchases, such as houses or automobiles. This confidence leads to increased spending, increased sales and earnings for corporations, further boosting GDP.
However, when stock prices are low, it affects GDP through the same channels. Companies are forced to cut costs and workers, businesses face difficulties to find new sources of financing. Existing debt becomes more onerous.
Due to these factors and the pessimistic climate, investing in new projects is unlikely. These have a negative effect on GDP.
Consumer spending drops when stock prices decrease. This is due to increased rates of unemployment and greater unease about the future. Stockholders lose wealth with stocks in a bear market, denting consumer confidence. This also negatively affects GDP.
Certain details suggest that today’s conditions influencing stock market performance may have changed.
The following factors can affect stock prices:
Interest rates. When interest rates go up, borrowings which a company makes to expand its business become more expensive. It decreases company’s profitability as well as company’s share price. In 2017, Federal Reserves raised interest rates three times. It is forecasted that three more rate hikes are expected in 2018.
Economic outlook. If the economy is going to expand, stock prices may rise as investors may buy more stocks as they may see future profits and higher stock prices. If the economic outlook is uncertain, investors may reduce their buying or start selling. In October 2017, IMF announced that it cuts forecast for the US economy removing assumptions of Trump’s plans to cut taxes and boost infrastructure spending to spur growth. In January 2018. IMF warned policymakers to be on guard for the next recession. About half of the IMF’s global upgrade stems from the Republican tax cuts passed in December 2017 and enacted this year. But the US’ current-account deficit will widen as stronger demand drives imports. The IMF also warned that a financial-market correction could spoil the party.
Inflation. Inflation means higher consumer prices, often slows sales and reduces profits and lead to higher interest rates. As a result, it brings down stock prices. IMF a possible scenario it raises amid “rich asset valuations and very compressed term premiums.” Higher inflation could prompt the U.S. Federal Reserve to raise its benchmark interest rate faster than expected, causing financial conditions to tighten around the world and sidestepping economies with heavy debt loads.
Deflation. Low deflationary risks
Economic and political shocks. Changes around the world can affect both the economy and stock prices. Project Syndicate reported that the global economy will confront serious challenges in the months and years ahead, and looming in the background is a mountain of debt which increases the system’s vulnerability to destabilizing shocks. Trump’s unpredictability shows that the US cannot be counted on to serve as a principal sponsor and architect of the evolving rules-based global system for fairly managing interdependence.
Changes in economic policy. Sometimes these changes can be seen as good for business, and sometimes not. They may lead to changes in inflation and interest rates, which in turn may affect stock prices. Trump’s economic policy of isolationism means that business opportunities for the US companies would be significantly reduced. Donald Trump withdrew from TPP and threatens to leave NAFTA, etc.
The value of the currency. When the price of the dollar falls, it makes it cheaper for others to buy US products. This can make stock prices rise. Despite a selloff in the stocks, the U.S. dollar, traditionally a haven in times of turmoil, is hovering near multi-year lows. It could see even more downside this year for two major reasons: Europe and China. The DXY U.S. dollar index ended January with losses of 3%, its worst drop in nearly 2 years, and its third straight month in negative territory.
Except for deflation, all other indicators show that the stock market’s optimism was absolutely groundless.
However, it is unlikely that the entire community of investors could have ignored fundamental rules. It leads to a question, what was driving stock prices up?
The stock market continues to be one of President Donald Trump’s favourite indicators of the country’s health as stocks continue to hit all-time highs.
According to a new analysis, the top 10% of American households, as defined by total wealth, now own 84% of all stocks in 2016, according to a recent paper by NYU economist Edward N. Wolff.
“Despite the fact that almost half of all households owned stock shares either directly or indirectly through mutual funds, trusts, or various pension accounts, the richest 10% of households controlled 84% of the total value of these stocks in 2016,” Wolff writes.
That number—which accounts for individual shares as well as stocks held via mutual funds—represents a big change from 2001, when the top 10% owned just 77% of all stocks.
When the vast majority of stocks concentrated in hands of 10%, is it possible to continue talks about the free market?
Illogical boost which was observed in recent months raises a suspicion whether the record-breaking highs of the stock market is a result of manipulations.
Whatever it might be, the US authorities would need to investigate the story of dramatic rise and fall because behind the numbers there are millions of real people who are affected by it.
It is time to learn our lesson. The 2008 financial crisis occurred due to actions of American banks which led to devastating consequences worldwide.
American banks managed “to get away with the murder”. If shady activities are behind the recent stock market fall, those who are responsible should face justice.
Otherwise, if no appropriate actions are taken, the reliability of the US stock market must be questioned.