Question

Is the stock market leading the economy or is the economy leading the stock market and why you think it is so?

In economics it is said the markets behave rationally can we trust that the market behaves “rationally”?

Answer 1

1)The economy is leading the stock market.

Reason- Economic factors such interest,rates,inflation,unemployment etc. provides direction to the stock market.If this factors are favourable,stock markets moves in positive direction and the vice versa.The more favourable are this factor,the more it will result in increase in value of stock,thereby driving the stock market upwards.

For example,reducing interest is seen s positive by the stock market as it is seen as the measure of economic growth. Similarly inflation can have negative effect on stock market because it can lead to increase in interest rates.

2)We cannot believe that market always behave rationally.

Reason- The market does not always behave rationally,there may be mispricing i.e undervaluation or over valuation in the market.A stock may be in oversold zone on the expectation of some negative development which causes price to fall more than normally it should have and the vice versa.

More or less,it can be said market behaves rationally in long term.However,it cannot be said that market is always rationale.