Hi and welcome to the third episode of EFFECTS of COVID-19 on the world Economy.
A quick recap before we begin. In the first episode we discussed about some of the basic economic fundamentals along with the business cycles, various indicators and the role of the central bank.
In the second episode we talked about the current economic state of the various countries across the globe.
In this episode we are going to discuss the impact of COVID-19 specifically on the stock market and its impact on the economy in context to recession.
So, what is the stock market?
Stock Market in basic terms is an excellent economic indicator for any economy. In general stock market is a Leading Indicator of the pace at which the activities are going to take place in the economy at any coming time. It also helps to know the sentiment of the Investors, for instance if they are confident that the growth in the economy is going to continue then they would buy more stocks, mutual funds etc. Thus, more money in the market will lead to higher prices of the stocks.
When large money is available in the market it leads to decrease in the borrowing rates since money could be raised at lower rates due to ample amount of liquidity in the market.
How does stock market effect the Economy?
Movements in the stock market can have a profound economic impact on the economy and individual consumers. A collapse in share prices has the potential to cause widespread economic disruption.
What Is GDP?
Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of the country’s economic health.
GDP is primarily driven by spending and investment. GDP is typically shown as a percentage growth rate from one period to another.
Key components that make up GDP:
- Consumer spending, which is the primary driver for GDP in any economy.
- Business spending, which includes purchases of new plant and equipment, hiring, investing in new technologies, and building new offices and factories.
- Exports, which are sales from domestic companies to customers internationally.
- Government spending, which includes building roads, bridges, and subsidies for industries, such as agriculture.
Together, all of the above-components that make up GDP can also be influenced by investors–either negatively or positively–through the stock market.
How are GDP and Stock Market related with each Other?
The stock market is often a sentiment indicator that can impact gross domestic product (GDP) either negatively or positively.
In a bull market–stock prices are rising–consumers and companies have more wealth and confidence–leading to more spending and higher GDP.
In a bear market–stock prices are falling–consumers and companies have less wealth and optimism–leading to less spending and lower gdp.
How Bull Markets Affect GDP
A bull market is when the equity markets are rising. The stock market affects gross domestic product primarily by influencing financial conditions and consumer confidence. When stocks are in a rising trend–a bull market–there tends to be a great deal of optimism surrounding the economy and the prospects of various stocks.
If companies issue new shares of stock to raise capital, they can use those funds to expand operations, invest in new projects, and hire more workers. All of these activities boost GDP. During a bull market, it’s easier for companies to issue new shares since there’s a healthy demand for equities.
If GDP is rising–meaning the economy is performing well–those same companies can also raise additional funds by borrowing from banks or issuing new debt–called bonds. The bonds are purchased by investors, and the funds are used for business expansion and growth–also boosting GDP.
With stock prices rising, investors–or consumers–have more wealth and optimism about future prospects. This confidence spills over into increased spending, which can lead to major purchases, such as homes and automobiles. The result leads to increased sales and earnings for corporations, further boosting GDP.
How Bear Markets Affect GDP
Conversely, when the stock market is falling–a bear market–it means that stock prices are going lower, and it can have a negative effect on sentiment.
In a bear market, investors rush to sell stocks to prevent losses on their investments. Typically, those losses lead to a pullback in consumer spending, particularly if there’s also the fear of a recession. A recession is two consecutive quarters of negative–or contracting–GDP growth.
Once consumers began to pull back spending, it can hurt the sales and revenues of companies. Companies, in turn, are forced to cut costs and workers. The fall in consumer spending is exacerbated by an increase in unemployment and further uncertainty about the future.
Also, businesses might find it difficult to find new sources of financing, and with less revenue coming in, existing debt can become more challenging to manage.
All of these factors lead to a drop-in consumer and business confidence, which translates to less investment in the stock market. The contracting spending and investment due to lower confidence, ultimately has a negative impact on GDP.
When GDP rises, corporate earnings increase, which makes it bullish for stocks.
Too long technical videos get boring after a while, therefore we will discuss more in the coming Episode.
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In the Upcoming Episode , we will be discussing about Effects of Market Crash, Beginning and Ending of Recession, Where are we headed and the different types of recoveries such as V-shaped , U shaped etc.
What Happens when the Market Crashes and how does it affect the economy?
Stock prices rise in the expansion phase of the business cycle. Since the stock market is a vote of confidence, a crash can devastate economic growth. Lower stock prices mean less wealth for businesses, pension funds, and individual investors. Companies can’t get as much funding for operations and expansion.
When retirement fund values fall, it reduces consumer spending. A stock market crash will adversely affect the nation’s gross domestic product as personal consumption and business investment are some of the major components of GDP.
Stock market crashes can cause depressions by wiping out investors’ life savings. If people have borrowed money to invest, then they will be forced to sell all they have to pay back the loans. Derivatives make any crash even worse through this leveraging. Crashes also make it difficult for companies to raise the needed funds to grow. Finally, a stock market crash can destroy the confidence required to get the economy going again.
If stock prices stay depressed long enough, new businesses can’t get funds to grow. Companies that had invested their cash in stocks won’t have enough to pay employees, or fund pension plans. Older workers may find they don’t have enough money to retire.
Growth rate decreases, Hundreds of thousands of jobs are lost, Unemployment rate peaks leading to decrease in consumer spending’s .
The housing and Infrastructure sector moves into slowdown with homeowners finding it extremely difficulty to pay mortgages due to job losses and ultimately it leads to foreclosure of their homes by the banks due to non payment of dues.
Debt increases to unprecedented levels, Non Performing assests spikes leading to chaos in the overall financial system.
The early estimates suggest that the global economy will contract by about 5 per cent on account of the Global Epidemic break out of COVID-19.
There have been about 7 global recessions over the last century. And it is very rare for the global economy to contract as such. Because, countries like China and India always register some positive growth. So this is unprecedented nature of the shock.
People are expecting around 1 per cent of contraction if the normal activity resumes by May this year and if that does not happen, we are looking at the worst global recession since the Great Depression.
What happens during Depression? Or to Say How would the life be during recession?
Businesses lay off workers and jobless workers have less to spend as a result..
The Depression can cause workers loose their job , Farmers lose their farms, Businesses lose their business while it may also cause Individual lose their homes on account non payment of Mortgages thereby making them living as homeless. Lower consumer spending reduces business revenue, which forces companies to cut more payroll. Economic Output plummets, GDP would fall, Consumer price index would also fall , Instead of Inflation there could be deflation, International Trade could shrink, Business Credit would froze up and demand for any Asset backed commercial Paper could dry up.
It may further lead to foreclosure of small business since without credit they cannot grow, stifling almost more then 50% of all new jobs that they provide. This downward cycle is devastating
Although unemployment rate is tied with the recession it spurts over the period of depression and after as well since it is a lagging indicator.
When an economy begins to improve after a recession, for example, the unemployment rate may continue to worsen for some time. Many companies hesitate to hire workers until they regain confidence in the recovery, and it may take several quarters of economic improvement before they feel confident that the recovery is real.
So When Do Recessions Begin and End?
A recession has started when a country or region experiences two consecutive quarters of negative real GDP growth. to revive the economy.
The peak of expansion often referred to as peak companies may be reluctant to take caution into account. The interest rates may be high, valuations may be far from stretched and debt levels may be at the peak. At the height of the boom phase, the economy will be said to be overheating.
The beginning of the contraction may take place because of restrictive economic policies established to tame an overheated economy or because of some other shock, such as energy prices or a credit crisis, the economy stumbles and starts slowing down.
Thus as a result of which Unemployment may start to rise and GDP growth rate may start on decreasing.
Initial signs may be increasing inventory to sales Ratio which may be followed by decrease in average weekly production output coupled with decrease in manufacturing index and thus hitting all other areas as well as indicators.
Generally once the economy enters the recession and hits the trough has hit it takes at least 2-3 quarters at minimum extending to 2-3 years to get economy back to normal or out of the recession depending upon the various measures taken by the government.
So where are we headed?
On the economic front, a severe recession can no longer be avoided, and some economists are already calling for governments to introduce measures to shore up aggregate demand. But that recommendation is inadequate, given that the global economy is suffering from an unprecedented supply shock.
People are not at work because they are sick or quarantined. In such a situation, demand stimulus will merely boost inflation, potentially leading to stagflation (weak or falling GDP growth alongside rising prices), when another important production input was in short supply.
Worse, measures targeting the demand side could even be counterproductive, because they would encourage interpersonal contact, thus undermining the effort to limit transmission of the virus.
So What good would it do to give Italians money for shopping trips, when the government closes the shops and forces everyone to stay at home?
The same arguments apply to liquidity support. The world is already awash in liquidity, with nominal interest rates close to or below zero nearly everywhere.
The past weeks have shown how a health crisis, however temporary, can turn into an economic shock where liquidity shortages and market disruptions can amplify and perpetuate.
The brutal decline in economic activities that epidemiologists say is required make crashing stock markets inevitable, given that central banks’ policy of excessively cheap money and pooled liabilities caused an unsustainable bubble
And because this time the shock is on both the demand and supply sides, the government’s conventional approach of stimulating demand by relaxing credit and injecting liquidity into the economy might well not work well for any of the economies.
As the novel coronavirus and the disease, it causes, Covid-19, continue to spread across the world, hopes for avoiding a global recession look increasingly unrealistic. All we can do is hopes for a short-term V-shaped. A U-shaped recovery might be possible, but even the worst-case L-shape model cannot be ruled out.
What is this V shaped , U-Shaped and L-shape recovery?
The above mentioned are some of the shapes of the recession. There is no specific academic theory or classification system for recession shapes; rather the terminology is used as an informal shorthand to characterize recessions and their recoveries.
In a V-shaped recession, the economy suffers a sharp but brief period of economic decline with a clearly defined trough, followed by a strong recovery. V-shapes are the normal shape for recession, as the strength of economic recovery is typically closely related to the severity of the preceding recession.
A U-shaped recession is longer than a V-shaped recession, and has a less-clearly defined trough. GDP may shrink for several quarters, and only slowly return to trend growth.
An L-shaped recession or depression occurs when an economy has a severe recession and does not return to trend line growth for many years, if ever. The steep drop or degrowth, is followed by a flat line makes the shape of an L. This is the most severe of the different shapes of recession.
Although there are very few chances of unprecedented recession to be avoided in short run, the one thing certain about the year 2020 is going to see global growth taking a big hit causing disruptions everywhere.
The global economy could be staring at a recession that is as bad as or worse than the global financial crisis of 2008 because of the Covid-19 outbreak, International Monetary Fund (IMF) managing director Kristalina Georgieva said.
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In the coming Episode which will probably the Last episode of this series we will be discussing about various measures taken by different countries to prevent the economy from collapsing and where we as investors should look for the silver linings.
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