The economy and individual wealth both get affected by significant movements in the stock market. A steep fall in the share price can disrupt wealth for a lot of people. Although, the impact of the share market is lesser on the overall economy.
A change in the share price is caused due to many reasons- there might be a correction due to overvaluation, but a sizeable fall in the share price does not mean the growth will be lower.
Investment and online trading in India have increased their base over the years. This has led to the rise in investors’ confidence in India, and if the share prices are plummeting, they make headlines soon.
Here are the economic effects of the stock market-
1. Wealth Effect
If the share market falls, people will start losing their wealth which will lead to loss of purchasing power. Loss of purchasing power is directly related to the demand, and thus demand in the economy will be significantly less.
People who undertake margin trading are at high risk. If the market is volatile, then the price movement against them can wipe off their wealth really quickly and make them liable to the broker as well.
2. Business Investment
Apart from losing purchasing power, a loss in business investment also increases the volatility in the overall economy.
When in the bull market, stock prices are high, the investors have more confidence in the market as everybody earns during the bull run. Many companies issue IPOs taking advantage of the optimism of the market.
In the case of a bear market, economic growth has the opposite effect. Investors and companies lose confidence in the market. It also makes it difficult for the companies to raise fresh funds and thus can not spend more to grow the economy.
Emotions play a very important role in stock markets. As we saw, in March 2020, panic related to pandemic and lockdown led to a crash in the stock market. Share prices are affected negatively when investors are scared of recession and global slowdown.
However, the equity/stock market always looks ahead at the future. There are times when the stock market shows more strength than the economy. Even during times of recession, the share market may outperform.
4. Bond Market
Fall in one market makes investing in another market look more attractive. Investors may want to move out of the equity market and enter the capital market. They may earn better returns in the time of uncertainty.
5. Other Factors
Pension funds are usually invested in the stock market to beat the rising year-on-year inflation. A sudden fall in the stock market will lead to a reduction of the fund value, which will then affect future payments. People who invest their pension fund in stock markets will tend to save up more, thus hurting the economic growth.
Whenever there is a correction in the share market, the bond market has a positive effect. Investors lookout for promising returns in times of economic depression and thus have more confidence in government-backed securities such as bonds or gold ETF.
The stock market and the economy are very different from each other. It is because of the size of both the markets. There are more factors that affect the economy than the stock market. The stock market is affected by simple demand and supply of shares, whereas the economy is affected by millions of factors.