The Interaction Between the Stock Market and Business Sector Investments and the Economy

Abstract

The growth recession that started in mid of 2000 lasted almost 3 years is a subject that got a lot of media attention but much lesser academic search interest. The fact that the stock market, inflated as it was prior to its prolonged collapse after March 2000, lost an equivalent of 30% of the USA GNP was frequently explained away with an assortment of explanations that really provided little true insight for such wealth loss. This was accompanied by a relatively modest unemployment of less than 6% (compared with previous recessions), robust real estate market, fairly resilient consumer spending, very accommodating monetary policy, tax cuts and deficit increasing fiscal policy, and yet a very weak Business sector investment spending. This study examines the interaction of the stock market and business investments. It shows that business investment reacts sooner than consumers to changes in the stock market. Gross Domestic Investments are found to be non-reactive at the first 5 months (with a small positive immediate response in the first 3 months), and rise (fall) after 6 more months or more of a strong (weak) stock market change which is sustained long enough to prompt new investments. There is faster response of business investments to a strong or weak stock market relative to consumers' response. This may indicate that businesses are more opportunistic than consumes, trying to capitalize on a strong stock market in raising capital and financing new capital outlays. In a break with previous thinking, the key to a business sector recovery seems to be more dependent on the strength of the stock market than previously acknowledged, as traditional thinking has focused on the relationship between business investments and consumer spending.