Monday, November 23, 2015

Does Stock market reflect the fundamentals of any country’s economy?

What is Stock Market?

To begin with, let’s first understand what exactly does the stock market mean. Stock Market is an index representing the movement in the share price of major companies listed in the Stock Exchange of respective Countries. It is a platform where the prospective buyers meet the sellers and vice versa to carry out the transaction of purchase or sale of shares. These buyers and sellers are investors who either are in possession of some shares of any number of companies or are willing or looking to buy shares of companies.

We also need to understand the mechanism behind movement of share prices. Basically, it is a demand and supply mechanism. The demand for shares is created by the Buyers and its supply is created by Sellers of the shares. The intention of any Buyer or Seller to transact at stock exchange is based on an opinion which is popularly known as market sentiments.
Market sentiments are based on Company’s press briefings, Industry specific announcements, Government’s macro-economic indicators like GDP growth, Inflation, Fiscal Deficit, Foreign exchange stability, Industrial Output, monetary policy etc.

Few Instances

The National Bureau of Statistics show that, in 2004, China's GDP reached 13.65 trillion Yuan (US$1.65 trillion), rising 9.5 % year-on-year. Meanwhile, the composite index of the Shanghai Stock Exchange dropped 15.15 %. China's GDP has maintained a growth rate of more than 7 % in recent years. But the composite index of the Shanghai Stock Exchange fell gradually, from 2,245 points on June 15, 2001, the highest point, to 1,187 points on February 1, 2005, a six-year low.

We can consider even Tehran Stock Exchange (TSE) for its performance. The TSE index has taken a serious beating since December 2013.  It reached close to 89,000 points before falling to less than 65,000 in early September 2013, when the ministers’ letter was written to President Rouhani.  The letter was written on September 9 2013 but came to light during December 2013.  The brouhaha that followed, however, was not about the TSE and what its poor performance means for the economy, which appears to be heading for a double-dip recession. Attention has instead focused on division within Rouhani’s coalition government and what it means for the future of his austerity program. This is a loss of more than one-third in the value of the index, and a similar loss in the wealth held by those who hold its stocks.  The decline in the index is even sharper if we correct for inflation, registering a loss of 48%.

But, before we feel sorry for TSE investors, we should consider the amazing run they had up to December 2013.  In the two years before heading south, the index had risen by 252% in nominal terms and 100% after accounting for inflation.  Even with the sharp decline since 2013, between December 2011 and September 2015 the index gained 9.4% per year in real terms.  This isn’t bad for an economy in recession and with negative interest rates.

So, it could be aptly derived from the above discussion that stock market is a good indicator of any country’s economic performance but it cannot be considered as a true indicator of any economy. The reason behind this would be that share price movements always reflect the market sentiments of investors. In other words, share market movement is purely investor’s perception which is based on Buyers and Sellers expectations about the future performance of the companies listed in stock exchange.

Concluding, it could be derived that movements in share prices may indicate economic health of the country’s economy, but never measure it. Economic health of any country could only be based on the key economic indicators.

-Manish Aakrit
 Student, INLEAD
 INBM, October 2015


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