The Relationship of The Stock Market And Our Economy

Stock prices move on expectations about the future, as news conveys information related to the economy and the direction of interest rates.  Generally, the relationship between the stock market and our economy often converges and departs from each other.

A rising stock market may indicate favorable economic conditions for firms, resulting in higher profitability. On the other hand, a declining stock market may signal an economic downturn. Over the long term, these trends are likely to show the economy and stocks in tandem. Day-to-day, those correlations may be harder to see.

The substantial rise in stocks has responded to our economy’s opening as lockdowns ease, and people return to work. That was not all to record-setting stock price movements as sudden as the S&P 500 index was its rally back to $3,193.93 on June 5th close. That is an astounding 42.8% climb through the latest close. The market is nearly back to the February 19th peak.

Typically, a company’s value should reflect the present value of its future cash flows. To calculate future cash flows, investors should consider several factors that affect whether the stock is overvalued or undervalued.

3 Fundamental Factors That Affect Stock Prices

1. The Economy Investors look at how economic growth drives demand for the company’s products and services: the more substantial the need, the stronger the company’s revenue, cash flows, and potential valuation. When investing, you should have a basic knowledge of the economy and the Fed’s role in correcting economic changes.

2. Industry-Related Matters Specific industries and their stocks–airlines, automotive, energy hotels, brick & mortar retail, restaurants-swiftly bore the brunt of the initial market decline due to the coronavirus impact. On the other hand, other industries benefited from the stay-at-home lockdown measures.

3. Company-Specific Aspects Learn about the company you are considering to buy or sell, specifically, understand that company’s relevant factors and its valuations. Investors look at specific expectations for growth in revenues, cash flow and earnings, balance sheet strength (e.g., liquidity and debt ratios), and corresponding valuation.

Volatile markets and economies impact our emotions. The more turbulent the market, the greater the likelihood we may be affected by our biases. Generally, we make investment decisions by relying on fundamental analysis to determine if a security is undervalued. If the stock market is efficient, the stock prices are rationally priced, fully reflecting all available information.

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