The Relationship Between the Stock Market and the Economy

EconWatch (8/17/20)

By Samantha Rodriguez

A free-falling stock market is not something that usually occurs. However, on October 29, 1929, that is exactly what happened. A record 16,410,030 shares were traded in that single day. Those of you up to date on US History may recall that this date falls at the beginning of the Great Depression, a time of worldwide economic devastation. While the market was only one of many reasons for the Great Depression, it greatly accelerated the nation’s economic collapse.

The stock market itself is a vital component of the free-market economy. It consists of trading stock, shares of ownership in a public company, in an effort by consumers to build their long term wealth. Generally, the stock market is observed and tracked using a major stock market index like the Dow Jones Industrial Average or the S&P 500. These indexes track the price movements on a select group of representative stocks in order to provide the big picture view of the market -- whether stock prices are increasing or decreasing, and by how much.

As investors predict how the economy will be doing when investing in stocks, the market is often used as an indicator for the future of the economy. However, while the stock market serves a critical role in the economy, it is not the same as the economy. The market is best represented by major companies and the upper class (groups that have more access to the market). In comparison, small businesses and the lower class have less access to the market and thus are less represented. Furthermore, the market is based on investor predictions and beliefs for the future of the economy. Still, historically speaking, a stock market peaks before the economy peaks, while a stock market crashes before the economy crashes. As such, the stock market reflects the economic situation in the long term, but not at a single given moment in time.

We can observe the relationship of the stock market to the economy in our current situation. Just as the Great Depression, today, thanks to COVID-19, there have been many unpredictable jumps in the stock market. However, after a rapid decline in the market, bottoming out on March 23rd, a timely recovery was made. The market peaked on June 5th, just under the market price from before COVID-19. This recovery was thanks to the liquidity -- cash -- pumped into the economy by the Federal Reserve in an effort to stimulate the economy. However, due to continued low consumer and general activity, the money ended up in the stock market. In this case, the economy and stock market have yet to reflect each other in the present.