The U.S. stock market, in simple terms, is an exchange of investors who buy and sell shares of publicly-traded companies. This activity exerts a major influence on how well the economy performs. The 1990s-era dot-com boom and the stock market crash of 1929 are just two famous examples of this particular phenomenon. Understanding the relationship between the stock market and the economy is important to your own financial health as well, since you're often affected in ways that aren't always obvious.
Creation of Wealth
To participating investors, the stock market represents one of the most significant and practical ways of creating wealth. One example is Walmart's May 1971 initial public offering of 100 shares, which cost $1,650. By the spring of 1999, those original 100 shares had grown to 204,800 shares worth $90 apiece, or $1.8 million, says Primer magazine. Conversely, an investor might prefer to stick with blue chip stocks, or established firms known for generating steady, if unspectacular returns -- since it's notoriously difficult to predict the next Walmart-style IPO.
Stock price performance serves as a measure of positive and negative economic activity, which is often fueled by investors' perceptions of how well the market is doing. Massive sell-offs or purchases can occur, depending on whether the market is seen as rising or falling. In a global economy, this type of activity creates a major ripple effect. For example, in August 2015, U.S. stocks lost $2.1 trillion in value, which wiped out all of the market's gains of 2014 and 2015, reports CNN Money. The situation reflected continual anxiety over the health of the Chinese stock market -- which plunged 40 percent in June and July 2015 -- and a decision to devalue its currency, the Yuan. How the market responds also guides policymakers' decisions on whether to intervene aggressively, and -- if so -- what types of measures are needed to restore investor and consumer confidence.
Funding of Business
At a practical level, the stock market drives interest rates, which affects large and small businesses' access to capital. When the market performs poorly, lenders often react by raising interest rates, which can make it costly or difficult for businesses to finance their day-to-day operations, asserts Entrepreneur magazine editorial director Ray Hennessy in his August 2015 column, "Four Ways Stock-Market Volatility Affects Every Business." Consumers will also end up paying higher prices for business loans, credit cards and mortgages, since the lender bases its rate on the level of risk they are taking. Faced with this response, consumers may spend less, which further shrinks the economy. "What they worry about, you need to worry about," suggests Hennessy.
The stock market's performance affects every consumer, whether he directly invests in a company or not. Pensions, individual retirement accounts and 401(k) plans all exemplify consumer assets that suffer when the stock market plunges, as Hennessy notes in his Entrepreneur column. Poor market performance lowers the overall balance of an account, which may force the holder to delay major life decisions like retiring from work. As of 2014, 89 percent of actively managed funds performed below market expectations, which analysts blamed on the continuing fallout from the Great Recession's impact six years earlier, CNN Money reported in March 2015.