How The Economy Affects The Stock Market

The stock market and the economy are closely related. Therefore, if you want to become a stock investor you need to have at least a basic understanding of economics as this will be crucial to your success.

In this article we will look at some of the ways the economy affects the stocks you buy and the stock market as a whole.

Economics & The Stock Market

An understanding of basic economic concepts will allow you to sort out the information you hear in the news so that you can decide what is relevant, and what is not relevant, to the investments you currently own or are planning to make.

Some of the things you should be aware about are discussed below.

The Stock Market & Supply & Demand

The laws of supply and demand are two of the most important economic concepts you will come across. Supply describes what is available, and demand describes what people are willing to pay for something.

The cheaper a stock becomes, the more people will want to buy it. The more plentiful a stock is, the less people will want to buy it.

The Stock Market & Cause & Effect

The law of cause and effect states that for every effect there is a cause. In terms of stock market investing, this means looking for financial news which will affect the health of a company and its stock value.

For example, if you hear that a particular industry is doing poorly then you many choose to buy stocks in that industry because you think that the value of those stocks may increase again in the future. Or, you may choose not to buy stocks in that industry.

Some things which may indicate that a company’s stock value is going to increase include:

1 – Positive News About A Company

If you hear in the news that a company is experiencing increased sales, or that a new product they have released has been very successful, then that company’s stock value is likely to increase.

2 – Positive News About An Industry

If you hear news about a particular industry doing well, or one that is expected to do well in the future, then companies in that industry are likely to see an increase in the value of their stocks.

3 – Positive News About A Company’s Customers

Since companies often buy and sell from each other, hearing positive news about company B which does lots of business with company A, means you are likely to see an increase in stock value for one or both of those companies.

4 – Negative News About A Company’s Competitors

If a particular company is experiencing a decrease in sales, or are in any other sort of financial trouble, then their customers may look for alternative companies to buy from.

This will increase the stock value of the company from which these customers now buy from.

Government Actions & Stock Value

One of the most powerful influences on the stock market, are the actions of governments. This may take the form of changes in taxes, laws or regulations.

Although it is important to note that other factors, such as the prospect of war or peace, can also affect the stock market.

Put quite simply, a government can directly or indirectly cause a company to go bankrupt, disrupt entire industries or even cause a depression. Of course the opposite can also be true.

For example, if a government passes a tax credit so that people use more environmentally friendly technology, the companies in that industry are likely to experience growth and an increase in the value of their stocks.

National Debt & Stock Market Investing

Paying attention to the health of the economy is extremely important when it comes to stock market investing.

In 1990s for example, many investors in the United States lost a lot of money in their stock market investments, largely as a result of a rapidly expanding national debt and money supply.

As the money supply increased, people began to invest in the stock market. This hyper-stimulated the stock market and caused stocks to rise 25% per annum for five straight years.

Since many people wanted to benefit from this high rate of return, they emptied their savings into the stock market, borrowed money on credit and borrowed against their home.

However, eventually all this spending started to slow down, because consumers and businesses were getting themselves too much into debt.

This slowdown then caused the sales of goods and services to slow down which affected the companies who sold those goods and services.

To make matters worse, many of these companies were already heavily in debt, and to cut costs, they started to lay off employees.

The effect of this was that consumer spending dropped down even further, because people no longer had a job or were unsure about their financial security.

Since most people had little or no money saved up and were in debt, they had no choice but to sell their stocks to pay their bills.

This is why studying economics is so important in understanding the stock market. It is very easy to overlook the fundamentals when the stock market is doing well, but as you have just seen, if you ignore the fundamentals eventually you will pay the price as a result.