Stocks are small pieces of ownership in companies, and the stock market shows whether these shares are increasing or decreasing in value. Investor expectations can fuel the stock market, driving it up or down as a result. The relationship between the stock market and the economy is important due to the pessimism or optimism of investors.
The people who invest in the stock market obviously watch it carefully. Even people who don’t invest probably hear about big gains or losses. Losses can result in big headlines that create consumer fear. Gains can be the opposite, resulting in major headlines trumpeting rising stocks that create consumer optimism.
Investors’ spending patterns may tie in with gains and losses in the stock market, but this is not a guarantee. Some investors allocate investment monies that are completely separate from other spending, and the two areas have no bearing or effect on each other. On the other hand, consumers with retirement accounts tied to a falling stock market often tighten their belts and stop spending, which can negatively affect the economy. Even people who are not investors often will allow the stock market to affect their spending when they see news reports about gains or losses in the stock market. These reports can motivate the non-investors to spend or save.
If stock prices fall, this can affect the financial well-being of publicly traded companies, because it cuts into funds available for business activity. Less business activity means less borrowing. Less business activity can also create a downward spiral that creates less work and fewer jobs, which affects the economy as a whole.
When consumers react to stock market losses by curtailing their spending, the economy weakens. The result is a reinforcement of the falling stock market and the weakening economy. Conversely, if consumers spend more because of stock market gains, the economy often gets stronger -- another self-fulfilling circle.
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