Does the stock market reflects the economy?
Why government takes measures when the stock market falls?
It is the million-dollar question that may ring when the Government takes measures immediately when the stock market reacts sharply. Whichever the government rules, they will immediately do these changes.
Why is that so? is there any correlation between the stock market and the real economy.
What does the stock market represents?
The stock market consists of private companies that are in the mainstream organized market. They come into stock market listing to make sure they get the necessary funding for their companies. On their initial listing, they will get the money. This process is called an IPO.
From then on, every quarter the price keeps fluctuating. Based on the performance Domestic investors and Foreign investors pool in their money. Any change in the taxation of companies, changes in capital gains taxation, any positive news will invoke these investors.
During the month of October, one such positive news came for investors of Tata motors.
Stock was battered for its poor performance, being laggard in domestic sales, its Jaguar land rover sales plummeted globally. Last month Tata sons the trust owner of Tata motors said that they will infuse a few thousand crores of money. This had brought back confidence in the stock and it rose more than 20% in 2 days.
Similarly, an instance happened with Infosys in October. The company which was known for its corporate governance had got some serious issues with top management. Some workers reported a problem with US security agencies and also in India. This had brought down the stock significantly in a day.
The above 2 are examples of concerns that happened with companies and how the stock was treated. There was some positive news from the Government that taxation rules will be relaxed and the overall stock market grew significantly for 2 days. This will affect the investors across the market and hence almost every stock rose.
Does the stock market reflect the economy ?
When I started investing, I never knew the significance of the economy and the stock market. I use to think about why the government is making changes when corporates were asking or even demanding. When I started reading about Value investing and about Warren Buffet, my perception changed that it is all for the economy.
The stock market consists of organized private companies that constitute the GDP of the country. Earnings must improve year on year for consistent growth of the economy. Based on the euphoria, the stock market may value the stock beyond its actual earnings. Eventually, the stock price will correct if the fundamentals are not in alignment with stock value.
Sensex also has PE and EPS calculations. This represents the actual growth of the listed companies. If this doesn’t improve year on year, the Sensex will fall for sure.
If you are thinking this as a speculative game, it will look like that. If you are thinking of it as investing in one business then it will reward you in a much better way. Can you think of starting a company like HDFC bank or Maruti now? It is difficult, but you can always invest in these companies and became a part-owner.
Now, do you still think the stock market as risky wealth creation avenue with lots of significant relationship with the economy.