The following blog post was written by our interns, Brady Gray and Mauria Ferrell.
What is the economy and what is the stock market and what do they have to do with each other?
The economy is all of the goods and services in the US. We measure the economy in terms of Gross Domestic Product (GDP) which is the dollar value of all of those goods and services.
The stock market is where the buying and selling of shares of publicly held companies takes place. A stock is a share in ownership of a company. Companies allow people to purchase stock so that they can get the capital they need to invest in new projects or machinery. Just over half of the U.S. population owns some stock. The stock market is forward looking: The price moves reflect how investors feel about the future of these companies based on economic expectations.
So, how do we measure the economy and the stock market’s performance? It is important to remember that they do influence each other, but they are not the same thing.
When looking at the economy we generally consider 3 key indicators. These indicators are the unemployment rate, consumer price index, and gross domestic product (GDP). If GDP is rising, that means the economy is growing. A falling GDP indicates that companies are producing fewer goods and people may lose their jobs. A recession is generally defined as a decline in GDP over two quarters – a shrinking economy.
As far as stock market performance, there are many indexes that follow the overall direction of the market. For instance, the S&P 500 tracks the performance of the top 500 largest publicly traded companies. While there are thousands and thousands of stocks out there, the stocks in this index represent a very large portion of the market’s overall value.
How are the stock market and the economy related? When GDP is growing, individual businesses areproducing more and expanding. A rising stock market is usually aligned with a growing economy and leads to greater investor confidence, which leads to more buying activity. When consumers buy more, businesses produce and sell more goods and services. All of this results in a higher GDP.
While the economy and the stock market are different, they influence each other in various ways. The stock market alone is not an indicator of economic health, but good economic health can positively influence the stock market. We use key indicators like GDP, consumer price index, and unemployment rate to tell us the true health of our economy. So, next time you go to invest in the market, keep in mind how the market and the overall economy are working together.
The graph below shows the total value of the stock market as a percentage of GDP (FRED).