How A Prolonged Stock Market Fall Impacts the Economy

The indian bear market

A stock market is part of free economy. Investors pump money into stocks to beat the inflation and make their money grow exponentially over a period of time.

The Indian stock market has been in a state of decline since February 2018, and we now in August 2019. It’s been a long and grueling 17 months since the broad market has been underperforming the indices, which are anyway propped up by a few heavyweight stocks.

All this when global markets are doing incredibly well.

That’s because global economies are doing good while India continues to suffer from myopic policies and inefficient execution of plans that are reactionary, when these should be proactive.

And the absolute worst thing about this prolonged slowdown is that the retail investor has been pumping in his savings into mutual funds whose ads are beamed regularly on TV.

Anyway, here are the consequences of what a prolonged stock market downturn can do to the economy:

1. When a stock market goes up, investors feel rich and they spend money around boosting the economy. When the broader market falls, more so for a prolonged period, investors feel poor and curb their expenditure. This impacts the economy negatively.

Erosion of wealth negatively impacts investor psychology and curbs his spending habits leading to a fall in the GDP.

2. Companies raise money from the markets by issuing stock. In a market that is static or choppy or negative, investors simply are not interested to apply for shares in the primary markets.

Of course, IPOs of high quality companies will always succeed, but even average companies doing well cannot expect to raise funds because of the general pessimism.

Moreover, 100 out of 164 IPOs in the past 10 years are trading below their issue price. That kills investor sentiment too, along with the general market conditions.

Therefore, in a depressed markets, companies cannot raise funds to grow.

3. The general mood of the investors turns pessimistic. They say that a happy country is a prosperous country – this adage gets reversed in a prolonged stock market slowdown. Investors lose their confidence in a falling market.

4. When retail investors move away from the market, and sell their stocks out, the shares are picked up by big players, mostly corporates. This narrows down the shareholding pattern and stock prices get more vulnerable to news, and when this happens, retail investors get more fearful of entering the market.

Now with that said, remember that stock market is not the economy, it is just one driver of the economy and a long term investor of a quality stock will always make money if he is patient.

Stock market is driven by how government enables business. If the policies are not conducive, both foreign and Indian investors will rush to buy stocks, and vice versa.

In 2017, after demonetization, investors sank a good part of their savings into the stock market. People rushed to buy and drove the market to dizzying heights.

Today the reverse is happening. Investors are capitulating and driving stocks down.

2017 excesses have corrected, and we have yet to see any excesses in 2019-2020. Maybe we will see a crash, maybe we won’t. But as of now, given the extra socialist policies of the government, it does make sense to sit on the sidelines.

 

 

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