You always hear the connection between recessions and stock markets. I understand a recession would trigger the stock market to plunge. But I don’t understand why and I also don’t understand the timeline of events of a recession and what’s happening with the U.S. economy overall during a recession.
In: Economics
There’s a lot of reasons. Despite claims to the contrary, the market is tightly correlated to the real economy. Now I said correlated, not matching. The market swings wildly and dramatically, up and down. But it’s overall movement and growth or shrinkage matches a (differently numbered) overall growth and shrinkage of the economy.
Some of this is reflective of the economy, some of it is causal. It can reflect that people are nervous and want cash to weather the upcoming storm. It can be causal in that dropping valuations change whether or not your debt is sustainable and therefore whether your business will survive, killing the salaries and spending power of both your business itself and your employees.
And then we can look at it from what recessions do to the market rather than the other way around:
Recessions are a drop in economic output. Usually they are caused by something financial, a lack of aggregate demand, which is to say incomes (personal, business, etc) are too low to finance work for all the people and factories. Obviously in this situation, businesses are worth less than before as they sell less to fewer people, and fewer people and institutions have money to put into the market.
Ack. Not helping a 5yo.
There’s so much more too it. But maybe I can whittle it down to what is *often* the case:
A lack of money relative to the size of the economy means the markets become cheaper as there’s less to invest, and the businesses are selling less so are worth less. And with the businesses worth less, they can’t borrow money as cheaply so their spending goes down and it’s a cycle.
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