Over my recent vacation, I had the opportunity to talk to a number of people about the state of our economy. Not surprisingly, almost everyone told me how things could have been handled differently. Armchair quarterbacking aside, some people offered opinions that caught me off guard. In particular, I was surprised at the failure to connect our sluggish stock market and its negative effects on non-investors. Most of the people I spoke to were under the impression that investors were the only ones experiencing losses. It’s important to recognize that a declining stock market has far-reaching consequences for our entire economy.
We don’t have to look too far back in America’s history to see how a depressed market can wreak havoc on our personal finances. Between 2008 and 2009, the markets plunged, taking with them countless retirement accounts, pension funds, and corporate earnings. In what seemed like a blink of an eye, trillions of dollars of wealth evaporated. The collapse rattled consumers and businesses alike, forcing many into the conservative holding pattern we’re still in. Confidence is the grease that keeps the gears of our economy moving, and when that’s removed from the markets, our engine slowly grinds to a halt.
Okay, so how exactly does this affect those of us who don’t invest? Well, the two most important components of our economy are businesses and consumers. About two-thirds of our economy is based on consumer spending, and when consumers are unsure about the health of their personal finances, they stop spending.
The same holds true for businesses. If consumers aren’t spending, companies adjust their production, trim their inventory, and cut back on their work force, all in an effort to maintain profitability. It’s also typical for businesses to adjust the benefits offered to employees. During difficult times, businesses have been known to adjust retirement benefits by eliminating pensions and reducing 401(k) matches.
And it’s not just a company’s decreased contribution that will affect your 401(k). Again, even though you may not be an avid investor, you 401(k) is tied to stock market performance, and when that declines, so does the value of your portfolio. I remember teaching classes after 9/11 and the 2008-2009 downturns and hearing countless stories of people losing 50, 60, and even 70% of the value in their retirement accounts.
A declining stock market also affects our nation’s housing market. By now, we’ve all become familiar with the issues plaguing the housing market since our good friends on Wall Street played fast and loose with the American Dream, but those problems are compounded when investors engage in large-scale sell-offs, and the market drops accordingly. Even though interest rates continue to be at historic lows, it has become increasingly difficult for many would-be homebuyers to qualify for a mortgage. As housing prices decline, banks become reluctant to lend, and signals from a struggling market only encourage banks to continue tightening their lending standards, to require higher credit scores, to shrink credit limits and raise minimum payments, and to make it generally more difficult to qualify for a loan.
Another aspect of our economy that is affected by a Bear Market is entrepreneurship. Americahas been described as the prosperity capitol of the world; however, a declining market makes it more difficult for the average person to launch a new business venture. First, most new businesses require funding to get off the ground. Entrepreneurs typically use their own funds, or borrow from lending institutions. When the stock market is in decline, people have fewer options available to get the capital they need. The personal savings that may have been used to fund the venture are often exhausted quickly, and, as we’ve already noted, lenders make it more difficult to qualify for financing during periods when they’re focused on minimizing risk – like now. And even if that new business gets off the ground, when consumer confidence is low, most people are reluctant to spend. This not only reduces the growth potential for a new business, it also limits the employment opportunities represented by expansion.
As you can see, even if you don’t play the market, much of our financial health is tied to the overall performance of the stock market. When investors look to cut their losses and wait for things to get better, things generally get worse for the average consumer, as shock waves ripple through the economy and into almost every aspect of our personal finances. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.