The stock market affects individual businesses in an economy in many different ways. In the United States there are just under 4,000 publicly-traded stocks that can be divided broadly into 11 global industry classifications (GICS). With daily movements across the board, there can be a multitude of effects.
Many analysts often zero in on the S&P 500 Index as a barometer for market performance overall and as such as one of the most influential drivers. Here we will look at two of the most basic affects for businesses: 1) consumer spending and 2) business operations.
The Stock Market and the Economy
Defined as the market in which equity shares of publicly-traded businesses are bought and sold, the stock market measures the aggregate value of all publicly-traded companies. Comprehensively, this can be represented by the Wilshire 5000, but generally, most analysts and investors focus on the S&P 500. Both indexes can be valuable tools for gauging the health of the overall economy, though occasionally stocks may be misleading.
Typically, stock market and economic performance are aligned. Thus, when the stock market is performing well, it is usually a function of a growing economy. Economic growth can be measured in several ways, but one of the most prominent is by following gross domestic product (GDP).
When GDP is growing, individual businesses are producing more and usually expanding. Expanding business activity usually increases valuations and leads to stock market gains.
Historically, steep market declines preceded the Great Depression in the 1930s as well as the Great Recession of 2007–2009. However, some market crashes, most famously Black Monday in 1987, were not followed by recessions.
The Stock Market and Consumer Spending
Often, consumers spend more during bull markets because they are making more from the effects of a strong economy and also feel wealthier when they see their portfolios rise in value. During bear markets, the economy is usually not doing as well and spending recedes. A simultaneous fall in stock values also creates fear for the loss of wealth and purchasing power as the value of investments contracts.
A rising stock market is usually aligned with a growing economy and leads to greater investor confidence. Investor confidence in stocks leads to more buying activity which can also help to push prices higher. When stocks rise, people invested in the equity markets gain wealth. This increased wealth often leads to increased consumer spending, as consumers buy more goods and services when they're confident they are in a financial position to do so. When consumers buy more, businesses that sell those goods and services choose to produce more and sell more, reaping the benefit in the form of increased revenues.
Stock market losses erode wealth in both personal and retirement portfolios. A consumer who sees his portfolio drop in value is likely to spend less. This reduction in spending negatively affects businesses--particularly ones that sell non-necessity goods and services, such as luxury cars and entertainment, that customers can live without when money is tight.
The Stock Market and Business Operations
The stock market's movements can impact companies in a variety of ways. The rise and fall of share price values affects a company’s market capitalization and therefore its market value. The higher shares are priced, the more a company is worth in market value and vice versa. The market value of a company can be important when considering mergers and/or acquisitions that involve shares as part of the deal.
Share issuance decisions can also be affected by stock performance. If a stock is doing well, a company might be more inclined to issue more shares because they believe they can raise more capital at the higher value.
Stock market performance also affects a company’s cost of capital. Companies must average the costs of both their debt and equity capital when arriving at a weighted average cost of capital, which is used for many analysis scenarios. The higher the expected market performance, the higher the cost of equity capital will be. As cost of equity capital rises, present value calculations lower because companies must use a higher discounting rate.
Companies may also have substantial capital investments in their stock which can lead to problems if the stock falls. For example, companies may hold shares as cash equivalents or use shares as backing for pension funds. In any case, when shares fall, the value decreases, which can lead to funding problems.
Lastly, positive increases in stock values can also potentially generate new interests for a particular company or sector. This can possibly add to revenue growth from sales or attract investors.