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Guest Post - The relationship between the stock market and the economy is complicated

By Vijeta Shrivastava - check out more of her work at Be Write Side

Comic image of a graph showing the market falling

In general, people consider that the stock market movement reflects the state of the economy of the country. If the stock market is zooming it is generally considered that the economy is in a good state, on the other hand, if it is underperforming then people think that there are some issues with the economy. Although, the stock market performs well when the economy is doing good because in a growing economy, profits of the companies increase, which in turn leads to a surge in the price of shares of the companies while the bad performance of the stock market means that the economy is not doing good, causing a reduction in the profit of corporations.

Many times the stock market falls even when the economy of the country is performing considerably well and many times the market continues to rise even when the economy is not in a good state. So the economy of a country defines the direction of the stock market, not the other way round.

Similarly, the simultaneous fall in stock market indexes across the world does not start a global recession. Consider the following stock market crashes in the past:

  1. The US stock market fall in 1929 caused huge panic in the confidence of consumers and businesses of corporations/companies were hit very badly. The sudden fall in the stock market triggered the great depression causing economic meltdown across the globe. The S & P 500 fell nearly 86% in three years and took almost 22 years to reach the previous peak. The share markets across the world fell taking cues from the US stock market.

  2. In 1987, the stock market around the world falls drastically (around 3.5 %) on the decision of interest rate cut by the federal reserve to increase liquidity in the market. The use of computer programs for large scale trading of stocks was also a major cause of the 1987 stock market crash. Countries like India and China were growing at a very good rate despite that share market of these countries crashes following the global indexes.   

  3. During the first quarter of 2000, Nasdaq and S&P 500 was cruising on the wave of rising shares of dot com (Internet technology) companies. Soon many technology companies got busted due to high debt causing market crash. The stock market in India, China and other developing nations also plummeted. 

  4. In 2007, the US stock market started declining after a series of defaults by subprime mortgage lenders. The bankruptcy of Lehmann Brothers caused an international banking crisis and the stock market across the globe declined. On March 6, 2009, Dow jones plummeted to 6,443.27. Nearly, all stock markets in the world seen meltdown during the period.  

  5. The global stock market crash of 2015 (24 August) was started from the crash of the Chinese stock market due to many factors including a slump in the growth of the Chinese economy, oil prices, etc. Shanghai composite index fell 8.5% in a single day causing sell-off in other markets including the US. This fall in index however affected the traders but not the global economy.

Out of five US market crashes discussed above only two (1929 & 2007) coincides with the start of the global recession. Now look at the two graphs given below, the first graph depicts returns from the S & P 500  and the next graph shows the GDP of the US since 1930.           

US S&P 500 stock returns
US GDP since 1930

Years of negative GDP growth is much less than the years of negative returns by S & P 500. Negative returns of S & P 500 and low growth are coinciding most of the time but in 1960 US GDP grown at nearly 5% but the return of S & P 500 was -1%. Similar trends can be observed in 1946 and 2003-04. 

Now just for the sake of understanding, compare the economic indicators of India and Pakistan their GDP, export, Import, Debt, Per capita Income, vulnerability etc. You would find  that India is performing comparatively well on most of the parameters but when you look at the returns of their share market, Pakistan’s stock market has performed far better than India in the last 16 years. Pakistan index (KSE 100) has grown 1,750 percent from 1,772 in 2000 to 31,000 in April 2020 while Sensex (Indian Index) has grown 597 percent from 5,005 in Dec 1999 to 29,893 in April 2020.  While the Chinese stock market has underperformed in comparison to both India and Pakistan.

Gauging the economy of a country by its stock market performance is not only difficult but also faulty. Although the stock market performed well when the economy does well and performs badly when the economy dwindled but it is not a clear indicator of the health of a country's economy. So, the relation between the stock market of the country and its economy is somewhat complicated.


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