Does Stock Market Really Represent the Economy of a Country?

The answer to this question is a bit more complex than a yes or a no, as we will explore the question and try to understand it.

Basics


A stock market is a place where shares are traded of listed companies in a stock exchange.


The economy is a cycle of production and consumption of goods in any particular market.

The Dog with Leash analogy

In this analogy, consider the dog to be the stock market, and the man holding the leash to be the economy. The dog might chase a butterfly or bark at another dog and not follow a straight path as the man holding the leash is following, but it cannot escape from the leash itself, It is bounded to some extent to be around the man.


So let’s break this analogy down, the stock market (the dog) is doing its own thing by roaming around and observing a particular company or sector, but it cannot be outbound by the leash that is economy which follows production and consumption concept, which is ideally directly proportional to the stock market, as if ideally the dog should also follow the path that the man holding the leash is following but this is not always the case. Because the dog gets distracted by other things around its environment, same as investors in growing sector companies.

The Central bank or Federal reserve

it is an institute that manages the monetary systems of a country

You would be thinking that federal or reserve banks should regulate the stock market to be aligned with the economy, but the federal reserve’s job is to maintain the man holding the leash, therefore the economy.

The Indicators are the game-changers

The stock market indicator is to predict the future of the market, therefore it is aligned to predict the market of the next day or month, whereas in the economy the indicators are backward, they are for inferring how a country or a sector did last year or month, for example, GDP.

This causes a fatal misconception about the situation of the market and the economy, And the following cases are observed

  • The economy to be down and the stock market keeps on rising
  • The opposite also occurs when the economy is up but the stocks are down.
  • In some cases, the stock market is a good indicator of the economy, for example in the 2000s dot com crash

So in a nutshell, In the short term stock market doesn’t represent the economy of a country.
But in the long term, it does represent it to some extent.

other blogs: Why did we invent Money?

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