Question

When analyzing key macroeconomics to assess GDP growth/decline, how would you measure the performance relative to sequential and year-to-year data?

How will your analysis assist you in determining the direction of the stock market?

Why do you consider the relationship between the economy and the stock market an integral part of the investment process? Explain your reasoning.

Please provide sources to for additional claification.

Answer 1

Macroeconomics is the study of behaviour of the economy as a whole. Both micro economics and macro economics are two different concepts as macroeconomics concentrate more on individuals and how they make economic decisions. We know very well that there are many factors that influence macroeconomics on the whole. These factors are analyzed with various economic indicators that explain us about the overall health of the economy.

Output, the most important concept of macroeconomics, refers to the total amount of goods and services a country produces, commonly known as the gross domestic product (GDP). When referring to GDP, macroeconomists tend to apply real GDP that takes inflation into account, as opposed to nominal GDP which reflects only changes in price. The nominal GDP figure will be higher if inflation goes up from year to year, so it is not necessarily indicative of higher output levels, only of higher prices. The rate of unemployment explains macroeconomists how many people from the available pool of labour (the labour force) are unable to find work.

The stock market affects gross domestic product (GDP) primarily by influencing financial conditions and consumer confidence majorly. When stocks are in a bull market, there tends to be a great deal of optimism surrounding the economy and the prospects of various stocks. High valuations allow companies to borrow more money at cheaper rates as a result allowing them to expand operations, invest in new projects and hire more workers. All of these activities boost GDP. In this environment, consumers are more likely to spend money and make major purchases, such as houses or automobiles. With stock prices in Bull mode, they have more wealth and optimism about future prospects. This confidence spills over into increased spending, which leads to increased sales and earnings for corporations, further boosting GDP. In a theoretical environment stock price increases should exactly match real GDP growth. The underlying economy of a country translates into a company’s profits, thus into Earnings per Share (EPS), which eventually determines the price of a company’s stock. However, this only works if a country’s economy is closed and all the valuations remain constant. When stock prices are low, it negatively affects the GDP through the same channels. Companies are forced to cut costs and workers. Company’s or businesses find it difficult to find new sources of financing, and existing debt becomes more onerous. These have a negative effect on GDP.

Falling share prices can hamper firm’s ability to raise finance on the stock market. Firms who are expanding and wish to borrow often do so by issuing more shares – it provides a low-cost way of borrowing more money. However, with falling share prices it becomes much more difficult.