How Does the Stock Market Affect GDP?
The stock market is often a sentiment indicator and can impact GDP or gross domestic product. GDP measures the output of all goods and services in an economy. As the stock market rises and falls, so too, does sentiment in the economy. As sentiment changes, so does people's spending, which ultimately drives GDP growth. However, the stock market can have both negative and positive effects on GDP.
- The stock market is often a sentiment indicator that can impact gross domestic product (GDP) either negatively or positively.
- In a bull market–stock prices are rising–consumers and companies have more wealth and confidence–leading to more spending and higher GDP.
- In a bear market–stock prices are falling–consumers and companies have less wealth and optimism–leading to less spending and lower GDP.
Understanding How the Stock Market Affects GDP
Before we can determine how the markets impact GDP, we must first review what drives growth in an economy. The U.S. economy's GDP is primarily driven by spending and investment. GDP is typically shown as a percentage growth rate from one period to another. For example, the quarter-to-quarter growth rate might be 2%, meaning the U.S. economy grew by 2% in that quarter on an annualized basis. Below are a few of the key components that make up GDP:
- Consumer spending, which is the primary driver for GDP in the U.S.
- Business spending, which includes purchases of new plant and equipment, hiring, investing in new technologies, and building new offices and factories.
- Exports, which are sales from domestic companies to customers internationally.
- Government spending, which includes building roads, bridges, and subsidies for industries, such as agriculture.
Together, all of the above-components that make up GDP can also be influenced by investors–either negatively or positively–through the stock market.
How Bull Markets Affect GDP
A bull market is when the equity markets are rising. The stock market affects gross domestic product primarily by influencing financial conditions and consumer confidence. When stocks are in a rising trend–a bull market–there tends to be a great deal of optimism surrounding the economy and the prospects of various stocks.
If companies issue new shares of stock to raise capital, they can use those funds to expand operations, invest in new projects, and hire more workers. All of these activities boost GDP. During a bull market, it's easier for companies to issue new shares since there's a healthy demand for equities.
If GDP is rising–meaning the economy is performing well–those same companies can also raise additional funds by borrowing from banks or issuing new debt–called bonds. The bonds are purchased by investors, and the funds are used for business expansion and growth–also boosting GDP.
With stock prices rising, investors–or consumers–have more wealth and optimism about future prospects. This confidence spills over into increased spending, which can lead to major purchases, such as homes and automobiles. The result leads to increased sales and earnings for corporations, further boosting GDP.
How Bear Markets Affect GDP
Conversely, when the stock market is falling–a bear market–it means that stock prices are going lower, and it can have a negative effect on sentiment.
In a bear market, investors rush to sell stocks to prevent losses on their investments. Typically, those losses lead to a pullback in consumer spending, particularly if there's also the fear of a recession. A recession is often defined by two consecutive quarters of negative–or contracting–GDP growth.
Once consumers began to pull back spending, it can hurt the sales and revenues of companies. Companies, in turn, are forced to cut costs and workers. The fall in consumer spending is exacerbated by an increase in unemployment and further uncertainty about the future.
Also, businesses might find it difficult to find new sources of financing, and with less revenue coming in, existing debt can become more challenging to manage.
All of these factors lead to a drop in consumer and business confidence, which translates to less investment in the stock market. The contracting spending and investment due to lower confidence, ultimately has a negative impact on GDP.
The stock market's impact on GDP is less discussed than the effect of GDP on the stock market. When GDP rises, corporate earnings increase, which makes it bullish for stocks. The inverse occurs when GDP falls, leading to less spending by businesses and consumers, which drives the markets lower. However, whether it's a bull market or bear market, the stock market has some level of impact–albeit indirectly–on GDP and the economy as a whole.