The notion that the stock market isn’t the economy just doesn’t hold up anymore

A Wall Street subway station near the New York Stock Exchange (NYSE) in New York, on Monday, Jan. 3, 2022.

Michael Nagle | Bloomberg | Getty Images

The stock market may not literally be the draw, but the distinction between the two is getting harder to draw.

With household ownership of stocks scaling new heights and the destiny of companies — particularly in the innovative tech sector — tied to their share prices, the fates of Wall Street and Main Street have never been so intertwined.

So as the stock goes through this volatile period, it’s not sending a particularly good sign for the broader growth outlook.

“In the last 20 years, we’ve had a financial economy that has grown significantly,” said Joseph LaVorgna, chief economist for the Americas at Natixis. “You could have argued a few decades ago that the stock market was not the economy, and that was very accurate. That is no longer the case today.”

No one would argue that the stock market is all of the economy, but it’s also hard to dispute the notion that it’s become a larger part of everyday life.

Through the end of 2021, the share of household wealth that comes from directly or indirectly held stocks hit a record 41.9%, more than double where it was 30 years ago, according to data from the Federal Reserve. A host of factors, from the advent of online trading to stock-friendly monetary policy to a lackluster global economy, has made US equities an attractive place to park money and earn nice returns.

It’s also made the economy much more susceptible to shocks on Wall Street.

“When risk assets fall and fall fast enough, there’s no question they’re going to hurt growth,” said LaVorgna, who was chief economist for the National Economic Council under former President Donald Trump. “If anything, the relationship is even better when asset prices decline than when they go up.”

How it works

The transmission mechanism between the market and economic growth is multi-pronged but fairly simple.

Stocks and consumer confidence historically have been closely linked, so when stocks fall people tend to curtail spending. The decline in spending slows sales growth and makes share prices less attractive when compared to future earnings. In turn, that triggers a market reaction that spills back into less wealth on consumer balance sheets.

There’s also another important point: Companies, particularly innovation-heavy Silicon Valley firms, constantly need to raise capital and look to growth in their stock prices to do so.

“In addition to the wealth effect on consumers, [the market] does investment decisions by companies, particularly the high-growth companies, the tech companies, that rely on raising capital through the equity market to finance their growth,” said Mark Zandi, chief economist at Moody’s Analytics.

“If stock prices are down, it’s much more difficult to raise equity. Their cost of capital is also a lot higher, therefore they’re not going to be able to expand as aggressively,” he added. “That’s another element of the line between what’s happening in the equity market and economic growth.”

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