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How the stock market affects the economy

The stock market is where individual investors, businesses, and financial investment firms go to buy and sell stocks. The stock market can act as a tool for companies to raise capital by “going public” or offering a predetermined number of shares to the public. The share valuations are determined by investor demand, the financial performance of the company, and the market growth expected in that industry. The activity in the stock market affects the value of each stock and has a powerful influence on the economy. How? We’ll get to that in a minute, but first, let’s look at the types of stock markets.

Types of stock markets

Many people do not realize that there are two types of stock markets: primary and secondary. The primary market is where businesses go to make their shares available to the public for the first time, called an initial public offering (IPO). These shares are purchased directly from the company. Once the initial offering has occurred, the company will be listed on the secondary markets, or stock exchange, where shares can be publicly traded. On secondary markets, stocks are sold, or traded, by investors, not by the company itself. When financial analysts and members of the public are talking about the stock market, they are generally referring to the secondary market.

What is the stock exchange?

The stock market includes several different stock exchanges. The main difference between the market and the exchange is that company shares are traded on the stock market (general term), but they must first be listed on a specific stock exchange. The exchange then manages the orders for buying and selling by matching prices and enforcing regulations set to keep trading fair.  Some of the largest, most active stock exchanges in the world include:

  • New York Stock Exchange (NYSE)
  • Nasdaq
  • Hong Kong Stock Exchange
  • Euronext
  • London Stock Exchange (LSE)
  • Toronto Stock Exchange (TSX)

The impact on the economy

We’ve stated that stock market activity affects the economy, and that is concerning to businesses everywhere. As many small business owners are still recovering from the economic impact of the pandemic, the war between Russia and Ukraine, and the Federal Reserve’s recent rate hikes, entrepreneurs must also be aware of stock market trends, which influence consumer spending and business operations over the next year. The stock market directly impacts the global economy in the following ways:

Economic confidence

Market volatility is a term used to describe the frequency and significance of changes in stock prices. When the volatility of stock prices is due to rising share values, the public views the economy as favorable. When volatility is showing a significant or rapid drop in stock prices, business owners and consumers fear an economic downturn, and investors sell off shares, driving down prices even further.

GDP

Gross domestic product (GDP) is used alongside the consumer price index (CPI) and unemployment data from the Bureau of Labor Statistics (BLS) to measure economic health in a country and produce an inflation report. When the U.S. stock market activity is reported as favorable, consumer spending increases which directly contributes to the GDP in the United States.

Inflation data

Since the stock market affects consumer spending, the GDP, and the overall U.S. economy, it also affects inflationary rates.  High inflation typically follows a stock market crash or rapid decline of valuations, and inflation affects small business owners with decreased revenues and increased borrowing costs.

Investments

The value and activity of business investments also contribute to the overall economic health of a country. When stock market activity is positive and share values are high, business investments increase. The rise in investment capital is due to public companies taking advantage of an optimistic market by issuing an IPO, more company shares, or considering possible mergers and acquisitions.

Market Indicators: bullish or bearish

The market is described as being a bull market when stock prices increase at least 20% from their most recent lowest value. A bull market gives economists reason to be optimistic about economic growth, investment potential, consumer spending, oil prices, and more. Alternatively, the term bear market occurs when stock prices fall more than 20% below their benchmark high value. Bear markets indicate an economic slowdown because investment portfolios decrease, consumer spending slows, and the GDP drops. Legend has it these terms come from days of yore when prize fights were held between a bull and a bear. In a battle, a bear swipes down with its paw (hence “bear market”), while a bull strikes up with its horns (hence “bull market”). Whether or not this is the origin of the terms, the mental image may be helpful in keeping the terms straight.

What happened to the stock market in October?

Historically, September is known as the worst month for stock market activity. The consistent record of decreased stock market confidence in September makes it no surprise that there tends to be a negative October effect, a market anomaly that predicts share values will decline in September and continue to decline through October. Well-known stock market crashes that occurred in October include the Bank Panic in 1907 and Black Monday in 1987, where the Dow Jones Industrial Average (DJIA), a benchmark stock index, dropped 22.6% in one day.

Despite market economists and entrepreneur strategists’ fears, the month of October 2022 did not bring a notable market crash. CNN called October “more treat than trick” for the month and according to CNBC, the “Dow posted its best month since 1976 and markets made a huge comeback in October.” The CNBC report goes on to attribute gains of 13.95% for the Dow, 8% for the S&P, and 3.9% for the Nasdaq composite. All indications are that the stock market may be heading towards a bull market in the next few months, even though tech companies like Microsoft and Apple showed declining valuations during the last week of October. Other markets, like the bond market, are also seeing positive turns as JPMorgan reported that “bond yields are already in a peaking process and that’s a good thing for equities if that belief catches on.”

The stock market performance in October is reported just days before the November Federal Reserve meeting is scheduled. At the meeting, the U.S. central bank, or Fed, will decide whether interest rates will be increased another percentage point again this year. Due to continuing rising inflationary rates, many experts on Wall Street are expecting the Fed to raise the rate by another 75 basis points to fight inflation. The results will not be published until after November 2, 2022, when Chairman Powell will discuss the changes to the monetary policy and treasury rates in a press conference.

How does the October stock slump affect small businesses?

Since the stock market affects economic health, it is no surprise that small business owners feel the effects on their bottom lines. As the volatility of the market is reported, the labor market, supply chain, inflation, value of international currencies, and consumer spending are all impacted which affects small businesses directly in the following ways.

Increased borrowing costs

The costs of capital, or borrowing costs, increase for small business owners when stock market activity drives higher inflation rates. The reason it costs more to secure capital is higher interest rates. Entrepreneurs that have current business loans with variable interest rates, where the rate fluctuates depending on the market rate, may see an increase in their monthly payment. Higher loan payments mean a decrease in cash flow and working capital for the business which may make it difficult to cover other operating expenses, like payroll.

The rising rates also impact business owners that do not currently have a variable rate loan. New business owners seeking startup financing or established entrepreneurs who are considering a large purchase, like real estate or an equipment repair, are also affected by the increased borrowing costs because repayment terms on new loans reflect a higher interest rate or annual percentage rate (APR).

Decreased revenues

Small business owners may notice decreased revenues around October stock slumps or periods of economic slowdown. This is mostly due to decreased consumer spending. As the stock market reports bearish markets, investors, and consumers lose confidence in the economy. They may be concerned about job security, investment income, or the increased cost of living. These concerns negatively impact spending, which hurts some small businesses that offer retail products or discretionary services.

Increased cost of goods

Entrepreneurs may also notice increased prices on inventory, office supplies, and shipping expenses. Since suppliers are also facing supply chain issues, labor shortages, and increased raw material costs, the increase is passed on to their customers: small business owners. Payroll costs also increase for entrepreneurs, because employees are experiencing an increase in the cost of living which supports a demand for higher wages.

Decreased investment income

Small businesses that depend on interest and dividend income from investments are directly impacted when the stock market crashes because their investments lose value. The decreased value of a business’s investments affects net assets on balance sheets, monthly cash flows, and the liquidity of the business.

What can small business owners do to overcome an economic downturn?

While the October stock market results were not as damaging as some experts expected, many small business owners are still battling inflation and a resulting economic downturn. Often the biggest stressor is the inability to predict the duration of the slowdown. Whether rising inflationary rates pose a short-term hardship or a long-term struggle for businesses, the following tips will help any business owner survive the economic downturn.

Increase income

Increasing revenues is the goal of all hardworking entrepreneurs. However, strategizing the best way to raise your monthly income is challenging, especially during an economic downturn. Some ways to increase income include:

  • Raising prices – It is not abnormal for business owners to pass the higher costs of supplies and labor on to their customers. If you believe your customers would pay more for your products or services (in economic terms, if your goods or services are “inelastic” or “relatively inelastic”, raising prices may be the key to increasing revenues.
  • Customer service – As sales drop, it is more important than ever to focus on customer loyalty. Be sure you are providing a unique value to your customers, in addition to the goods and products you provide. This can be achieved through follow-up calls or emails, extended services, and customer appreciation events.
  • Marketing – Now, more than ever, it is critical to invest in the prospect of new customers. Reexamine your current marketing strategies to see if there’s cost-effective room for improvement, like increasing social media advertising for the upcoming holiday earnings season.

Decrease expenses

A business’s bottom line depends on more than just revenues. Business operating expenses greatly impact profitability, so tough economic times are the time to cut costs.  Some ways to save on expenses include:

  • Renegotiate contracts – Reach out to vendors that you work with on a contractual basis, like landscapers or janitorial services, and see if you can decrease your rates. Consider getting competitive bids to compare to your current costs to increase your negotiating power and provide an alternative option if you can’t reduce the rate.
  • Buy in bulk – Check with your inventory and supply providers to see if they offer a discount for bulk orders. If so, consider reallocating your budget to stock up on necessary materials.
  • Offer non-financial employee incentives – Retaining employees can be a struggle during an economic slowdown, but there are ways to reward your staff without opening your pocketbook. Consider offering your employees more time off, a remote working environment, a cause-based culture, or flexible hours.

Bottom Line

Historically, October is a scary month for the stock market. However, this year October showed better results than most analysts were predicting. Despite the positive impact of the stock market, small business owners are still fighting rising inflationary rates, decreased revenues, and increased borrowing costs. To thrive during an economic downturn, consider raising prices and cutting costs whenever possible. If your small business is still experiencing cash flow shortages, consider working with Biz2Credit on a small business loan option, like this manufacturer who was able to secure a $300,000 business line of credit, provided at the Prime interest rate.

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