To understand the effects that tough economic times have on the stock market, it is important to speak about what is an economic slowdown or “recession.” As defined, recession is the decline in the gross domestic product (GDP) growth of a country for two or more consecutive quarters of a year. However, the effects of recession are visible to all since several quarters before it actually happens, as the economy slowly “dries up.” We have seen even by historical facts and figures that a bullish and growing economy is always followed by a bearish market trend. On an average, if the economy has flourished for 6-10 years it is normally followed by a period of negative growth of 6 months to 2 years.
Effects of a recession can be varied; it impacts the stock market in a very big way and gives rise to several other consequences.
The stock market and recession is very closely linked as the stock index reflects the buoyancy of the economy. Recession can cause the stock market to crash indicating tough economic times ahead. This leads to reduced share prices, lower profitability, and lower dividends. Share prices decline even ahead of a recession, which is bad news for the stock market. The stock market is said to be “falling.”
During a recession, consumers lose confidence in the growth of the economy and spend less. This leads to a sharp decline in the consumer demand. This also means less investment in stock trading.
Yet another fearful outcome of the stock market crash is unemployment. Companies lose millions when the stock market crashes. Some companies, even big names, can go bankrupt due to this. This creates a rise in the unemployment. People are laid off by organizations in order to bring stability and suffice for the losses incurred as an effect of the recession.
Recession also leads to a sharp decline in the government budget due to low tax revenue (income tax, corporation tax, etc.). The government also tries to reduce the woes of the people through increased spending on unemployment benefits. Thus, this affects the economy as a whole.
Another effect of the economic meltdown is reduced demand leading to reduced wage inflation. Thus, the inflation rates decline sharply.
Investments are impacted is a grave manner at times of recession. With declining consumer confidence, investments in both the stock market as well as other sectors, such as the real estate, reduce to a minimum.
Profitability of Businesses:
Companies have to really struggle hard to survive the credit crunch in the money market. Small and large organizations may be wiped out completely by the effects of a prolonged recession.
Other effects include the increase in the number of repossessions by homeowners, reduced percentage of mortgage lending, reduced credit for consumers, decline in the pension schemes offered, salary cuts for employees, etc. However, on a positive note, this may be an opportunity for investors to buy shares at low prices and gain profits in the long term. Also, it must be kept in mind that recessions do not last forever. A downturn in the stock market is always followed by an upheaval and a bullish market. This leads to the recovery of the economy as a whole.
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