Recession and the Stock Market
A recession and stock market performance are, of course, closely related. As we all know, a stock represents company ownership, so the stock market reflects the level of confidence investors have in the future earnings of companies.
These corporate earnings depend on the health of the economy, making the stock market an indicator of the current state of the economy.
In a growing economy, output is increasing and most companies will see increases in profitability. A higher profit makes company shares more attractive by offering the opportunity for both capital gains (through stock price appreciation) and dividends (if the company pays a dividend) to the shareholder.
The Stock Market as an Economic Indicator
Many people look to the stock market to determine how the economy is doing. It is considered to be a mirror of the general belief about the direction of the economy. When the stock market is dropping, it can result in loss of confidence in both the stock market and the economy on the whole. While the stock market does not directly affect the economy, it is understood that when the stock market is in a sustained decline, the economy is likely to follow. However, the evidence does not suggest that the stock market drives the direction of the economy.
A Series of Swings in the Market
It’s interesting to note that the initial reaction of the stock market to bad economic news is often a rally based on the belief that Fed policy will be introduced quickly to fix the issues. It will not be a sustainable rally though if investors determine that a recession is imminent. In fact, several rallies and sell-offs may occur as the Fed continues to react to bad economic news. If the recession is real, the equity markets will eventually fall sharply marking the beginning of a bear market.
Definition of a Bear Market
A Bear Market is usually defined as a market that loses 15% as measured by a stock market index, such as the S&P 500. The historical average length of time for a bear market is about 1.5 years.
Recession and the Stock Market
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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