The stock market is down for the first time for a long time. It’s also at the lowest point this year (since Jan 1).
In this article, you’ll find out exactly how the stock market relates to the US economy.
Okay, so first, what is an economy in general?
As explained by Investopedia, an “economy is the large set of inter-related production and consumption activities that aid in determining how scarce resources are allocated. This is also known as an economic system.”
When most people say “the economy” they’re referring to the collection of buying and selling goods by consumers (like you and me), corporations, and governments. What you buy as a consumer and whether you choose to use cash or credit to purchase it impacts the economy in a small way. However, consider how much all consumers – aka people in the economy – are buying. The group as a whole spending money or not illuminates collective macro trends, which says a lot about the economy. And then with companies, what they borrow for money to develop/grow, what they sell, and how much of it they sell. Are companies selling enough to fund their organization to develop more product, to sell more product to people? Are people buying the goods because they have the money, and are confident enough to spend their money instead of saving it? All of these purchases or non-purchases together, develop the core of the economy.
For further explanation of full view of an economy, this Ray Dalio video does a phenomenal job. Watch the first few minutes to see how he explains an economy.
(Also, never heard of this guy? Here’s an excerpt from Ray Dalio’s Wikipedia page: Dalio is an American billionaire investor, hedge fund manager, and philanthropist. Dalio is the founder of investment firm Bridgewater Associates, one of the world’s largest hedge funds. As of January 2018, he is one of the world’s 100 wealthiest people, according to Bloomberg.)
Next, what the hell are stocks and why do we care about them?
The stock market is marketplace composed of a collection of company stocks.
Stocks allow everyday investors, aka the public, to own a part of a company. Without stocks being available for purchase, only private equity companies and investors would profit from the free market economy.
Companies need stock because they provide them the capital (aka cash money) they need to grow. Money helps them hire more people to create more product to sell, more sales reps to help sell the new product, and so on and so forth. This growth hopefully gives them a competitive advantage to continue to grow and succeed in today’s competitive landscape.
And to sell stocks to the public (aka not people who work for the company or were angel/seed/venture capital investors in the company), a company must launch an Initial Public Offering (aka an IPO). This IPO process raises a lot of capital for the organization, and signals to buyers everywhere that the company has operational excellence and is successful enough for the whole IPO process. When a company goes public, it goes from being owned by the business founders/investors/employees (who own stock) to be owned by the public, or “the market.”
Lastly, stocks indicate to the market, investors, and voyeurs who watch the market from the sidelines just how valuable a company is. For example, when stocks price increases, it means investors think the company’s earnings will improve. Falling stock prices mean investors have lost confidence in the company’s ability to grow. Most often, confidence is tied to profit margins.
However, lately, with the emergence of the internet, you’ll see other factors begin to shape a company’s stock price like:
- How happy employees are – look at Glassdoor.
- how excellent their offering is perceived by the market – G2M Crowd for the software industry.
- And how well the company is run. For example, Ubers massive executive fiasco which caused many people to predict the company is on its way from hero to zero.).
Think of the stock market as voting, but with money.
A caveat: The stock market has it’s problems. Some people, like “The Lean Startup” author, Eric Ries, is trying to create a new and improved stock market which focuses on the long-term health of companies instead of immediate short-site of the everyday investors. Read all about it here.
Back to our conversation at hand.
How does the stock market tie to the US economy?
Often people think the stock market and the US economy are directly correlated. Meaning that if the stock market is up, the economy is good, and if the stock market is down, the economy is bad.
The stock market is not the real economy.
As explained in the Ray Dalio video above, the economy is the culmination of stuff that we buy, sell, and product. That’s the accurate barometer. These numbers lead to metrics we focus on like whether we have enough jobs, what kind of jobs, are we at full employment, are wages growing, are consumers/people confident.
The stock market is an obvious, easy to explain, metric of the overall economy. Think of the September 2008 recession? For many, it began with the plunging stock market. However, it actually began in late 2007. Housing prices had been declining, and it became clear that housing prices had been inflated. Thus people weren’t going to be able to pay their mortgages. Then, fear spread throughout the economy as it does as a preamble to a recession. In the daily, they mention that banks stop lending, businesses saw their revenues decrease, businesses started laying people off.
To help the economy, the Federal Reserve dropped it’s interest rates to the lowest level ever – close to zero. Then started to buy up assets to make money and credit available again. They do this in hopes that people invest, buy, and spend more money.
When people are working, and companies are hiring, and people have enough discretionary income to buy things – they should also have enough money to invest. In their 401(k), where stocks are often a portion of the overall investing portfolio. Or invest outright in investment vehicles beyond the retirement ones (like 401k).
However, if you think about it, traditionally “the rich” are the ones who have *enough* extra money to invest in the stock market. While it’s changed slightly because the internet has made everyone a bit more educated bringing investing opportunities to more people, a few wealthy people can still buy enough stocks to impact the market.
As discussed in yesterday’s New York Times “The Daily” podcast, “Financial institutions have outsized influence over stock prices, and people who run financial institutions have directly, personally benefited from the policies of the Trump administration. He’s stripped away regulations and delivered a generous tax cut, giving Wall Street a sense that the party is back on.”
In the aftermath of the 2008 recession, it took a lot of regular Americans gaining confidence and investing in the stock market for the economy to turn around, but now we’re seeing that the stock market can boom based on the confidence of a relatively small group – in this case, a small group of wealthy people. Like we see happening right now.
As mentioned above, to strengthen and improve the economy, people need to spend money. And to spend money, they need to have the money. And to have the money to spend, they need increases in wages. We haven’t seen a real meaningful increase in wages in too long.
Unless you work in tech.
As we cap this off, keep in mind that interest rates will probably be rising soon.
The Fed is currently looking for signs of inflation, thus increasing (and really normalizing) interest rates – which means borrowing money and buying will slow down. Interest rates are still too low, and this means the Fed won’t have the ability to lower them in the next recession, which will inevitably happen, to increase spending again.
Ready to start investing? It’s time.
As my favorite quote goes, “If not now, then when?” Even a little as $20/month is a great start. It’s as simple as downloading a smartphone app to get started. The two are:
- Acorns: Free to start, no minimum to begin, but a ridiculous $1 a month fee – only use if you invest over ~$200 or more a month. Sign up using my code, and we’ll both get $5 free.
- Robinhood: There’s a waitlist right now, but leave a comment on my article, and I’ll send an invite. $5 minimum to get started.
Worried about the recession and want to wait it out? Don’t! I’ll leave you with this lovely insight from my favorite, Tony Robbins.