Stock Market and Federal Reserve System - Essay Example

Stock Market Introduction The term 'the stock market' is a notion for the system thatenables the trading of company stocks (collective shares), other securities, as well as derivatives. Bonds are still traditionally traded in a casual, over-the-counter market identified as the bond market. Commodities are traded in commodities markets, with derivatives are traded in a diversity of markets. The size of the worldwide 'bond market' is estimated at $45 trillion. The size of the 'stock market' is estimated at about $51 trillion. The world derivatives market has been estimated at about $480 trillion 'face' or nominal value, 30 times the size of the U.S. economyand 12 times the size of the entire world economy. The major U.S. Banks alone are said to account for well over $200 trillion. It must be noted though that the value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. (http://en.wikipedia.org/wiki/Stock_market) Section I The Federal Reserve System The Federal Reserve System (The Fed) is the central banking system of the United States. It was established in 1913 as a quasi-governmental/quasi-private banking system it is companies of (a) the presidentially-appointed Board of Governors of the Federal Reserve System which is in Washington, D.C.; (b) the Federal Open Market Committee; (FOMC) (c) 12 regional Federal Reserve Banks situated in major cities all through America acting as fiscal agents for the U.S. Treasury, every one of the nine-member board of directors. At present, Ben Bernanke is the Chairman of the Board of Governors of the Federal Reserve System. GDP: Gross Domestic Product is the total market value of all the final goods and services produced within a nation's borders in a given time period. Each goods and services produced and brought in the market has a price. The price of the total output is called as GDP. It can be measured by either cumulating all the income earned in the economy or all the spending in the economy and both measures should roughly equate to the same total. GDP is the basic measure of an economy's size. With the GDP used as a key indicator of economic activity and future economic prospects, any significant change in the GDP, either up or down, can have a major effect on stock market investors' sentiment. If investors believe that the economy is improving, and corporate earnings improving along with it, then they are more likely to bid stock prices to higher levels. Conversely an actual or expected decline in GDP is very likely to run in parallel or in advance to a declining stock market. There is an alternative view to the interplay between GDP and the stock market. The stock market itself may exert a reverse effect on subsequent economic activity: a fall in the market may erode personal wealth, real or perceived, such that individuals will stop spending. With consumer spending representing around two-thirds of GDP, even a small change in consumption can exert significant negative effects on GDP. This is referred to as the "wealth effect", where if investors feel poorer, they will stop spending, thereby decreasing GDP and further exacerbating an already declining market. The Housing Market: The housing market is one of 10 leading economic indicators and a good measurement of discretionary spending by the general public making up 5% of the value of the overall economy. When the economy is up, people have a tendency to spend more and housing permits and sales are good indicators of this trend. When the economy slows people spend and building and buying will have a tendency to decline. The concern in the current housing market is with the recent surge in defaults with sub-prime loans. This trend is a major factor in the current decline of the housing market which can act as a deterrent to growth and can cause a ripple effect in the rest of the economy. The housing market is an excellent economic indicator, and with historical perspective reflects cycles of growth and decline. While the market has been in a decline current figures suggest that existing home sales are on the rise and new building permits may be headed in the same direction. The most recent information available from the Department of Housing and Urban Development is from the 4th quarter of 2006. According to the National Data on Housing Production, the number of permits for the construction of new housing units was down 9% in the 4th quarter of 2006 and down 27% from the 4th quarter of 2005. The total number of permits issued in 2006, 1,837,300, was down 15% from 2005. In relation to the overall economy, the housing market is not considered a huge market mover. However, the Census Bureau reports that the housing industry represents over 25% of investment dollars and a 5% value of the overall economy the focus on the number of new building permits issued for private housing units as an economic indicator requires that data be gathered and reviewed on a regular basis. Housing starts or construction reports are an effective tool to understanding the current position of the economy. Housing starts can denote how much money the general public has. If there is an increase in home construction it can likely indicate that there is an increase in money available in the economy. The intent of this discussion is to look at the housing market and determine how it calculates into the economy, review the history, determine the current climate of the market, identify a long and short term goal for the market, and predict the next quarter of activity. If there is consistent growth in housing starts and construction, the Federal Funds Rate might likely be considered low because individuals are willing to borrow money from the bank to start these homes. The housing market can be closely related to mortgage rates and the bond market. Forecasted interest rate activity can be attributed to the fluctuations in the housing market. It can be expected that as interest rates rise there would be a decline in the housing market Employment rate Employment rate is a measure of the number of jobs that individuals already have Interaction between employment protection and the stock market when wages are sluggish or fixed. We build and calibrate a dynamic model where firms decide upon capital utilization, investment, vacancy posting and layoffs in order to maximize shareholder value. Public policy, devoted to employment protection, is parameterized through firing costs. (linkinghub.elsevier.com/retrieve/pii/S0264999304000355) Consumer confidence and spending How much confidence that consumers, or the public, have in the present and future performance of the economy, which is a key determinant of the aggregate, demand curve and the source of business-cycle instability. Consumer spending is the one key to any market economy. On the airwaves, there's never a shortage of data, analysis and cable commentary regarding consumer behavior. (www.investopedia.com/articles/fundamental/103002).Depending on the economy's sheer breadth, consumer spending can range anywhere from 50-75% of GDP. In the U.S. and most highly industrialized nations, this percentage is about 65% of total spending. The first part of measuring total consumption is measuring consumer sentiment, which is derived completely from a consumer's standpoint. When more people are working, this means that consumer spending will be higher, and the GDP will be higher. As the GDP increases, the economy stands at a greater risk of inflation, which, as we have seen above, is unhealthy for the stock market. Consumer Confidence is a very important measurement also watched in the economy, the consumer confidence level. Think about when you get all excited and worked up doing something right, making all of this money and then it is all gone. Not only are all your profits gone, but now you have lost money. Your confidence in those companies are hurt badly Low inflation has the effect of increasing consumer confidence, which in turn impacts on investment in the stock market that increases, due to the stabilization of the environment. Foreign trade Foreign trade consists in the exportation and importation of goods, or the exchange of the commodities of different countries. (dict.die.net/trade) Foreign trade yields a positive effect on the stock market as when one country trades from another country the stocks go high and thus in turn the foreign trade yields a good and sound data. Price, wage and productivity Prices determine how resources are to be used. They are also the means by which products and services that are in limited supply are retained among buyers. The price system of the United States is a complex network composed of the prices of all the products brought and sold in the economy as well as those of a myriad of services, including labor, professional, transportation, and public-utility services. The interrelationships of all these prices make up the "system" of prices. If the prices of the stocks fall then the stock market also will drop or will eventually will crash, whereas if the prices hit sky high then the stock market will be earning a lot as people will start investing in stocks. Wage is the payment usually of money for work or services usually according to contract the payment is done on an hourly or daily, basis the stagnating wages have extremely bad effect on the stock market. The lack of buying power with no use of credit will finally take the market down by approximately more than 60%. In economics, productivity is the quantity of output created (in conditions of goods shaped or services rendered) per unit input used. For example, labor productivity is characteristically considered as output per worker or output per labor-hour. By respect to land, the "yield" is corresponding to "land productivity" The wealth has heavy effects on consumer demand emanating by means of rises in the stock market are enormous, and the rises in the stock market are related to quicker productivity growth. Futures Market Futures market is an auction market in which participants buy as well as sell commodity/future contracts for delivery on a specified future date. Trading is carried on through open yelling and hand signals in a trading pit. (www.investopedia.com/terms/f/futuresmarket) When the futures market takes in billions of dollars within minutes, it causes the futures market as well as the stocks to crash from volatility. Moreover, common stock holders in condition will want to sell at the same time. Thus the market cannot handle bulk orders at once and a good number people won't be able to sell because no buyer will be ready to buy them a good example of this is the 1987 stock crash. Section II Long term effects of volatility Bull Market and Bear Market. A Bull Market indicates that the state of economy is excellent, there is no unemployment, the gross domestic product (GDP) is rising, and the stock prices are up. A Bull Market is accompanied by means of growing investor confidence as well as it inspires the investors to pay for stocks in expectation of more capital gains. Throughout a bull market choosing stocks is a lot easier for the reason that everything has an upward trend. An overstated bull market partial by overconfidence as well as conjecture can produce a stock market bubble. Bull markets cannot be a recurrent condition as well as from time to time can head towards unsafe circumstances if there is overvaluation of stocks. A Bear Market indicates that the economy is awful, recession is pending, and stock prices are going down every day. A Bear Market is constantly is related with far-reaching doubt. Investors panicked by means of anticipation of additional losses are aggravated to sell stocks. It is extremely complicated for investors to decide a profitable stock throughout Bear Markets. One way to make money throughout bear markets is the short selling method. Another approach consist of waiting on the sidelines until there is a reaction that the bear market is going to end, as well as beginning to buy shares just when there is an anticipation of a bull market. An overstated bear market is frequently accompanied with moribund investor confidence as well as panic selling and might result in a stock market crash as well as ensuing recession. Correction A price reaction (usually negative) of at least 10% for a stock, bond, commodity, or index. True fortunes are made during times of economic distress or financial corrections. Only one year before he completed the formation of U.S. Steel (which financial historians have called the deal of the 20th century), J.P. Morgan said that such a feat could never be accomplished by any man - until the markets crashed. The depressed valuations of the companies involved allowed him to purchase the business entities at a fraction of what they had been selling for twelve months earlier. (beginnersinvest.about.com/cs/marketanalysis/a/020301a.htm) Recession The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters. Investors bought and sold stocks based on astrological factors or Barry Bonds' current homerun total then these would be causing the price of stocks to change. In a situation like that, it would seem that the stars are causing the price of stocks to change; the economy would have nothing to do with it. It is because a large number of investors act on this inherent value principle that the economy tends to follow the stock market. Investors are constantly watching macroeconomic variables to try and determine when the next downturn in the economy will happen. Investors are often right when they predict the future growth rate of the economy. As a result, they often sell off their shares before the economy goes into a decline making it look like the stock market is causing a recession. In reality the causality runs the other way because the two things that causes price to change are changes in supply or changes in demand. (http://economics.about.com/cs/stockmarket/a/stock_recession_2.htm) Historical long-term performance In the 1990's the New York Stock Exchange where the stocks of approximately 3,000 companies are traded amongst investors every day- had its longest ever "bull market" (a era when stock prices rise ) in its history. The NASDAQ a stock exchange where the stocks of about 3,300 companies are traded daily too experienced record performance. Subsequent to a persistent period of fast stocks/shares value expansion, it takes time throughout the downturn for memories of disappearing paper profits as well as high profile corporate failures, to weaken. So the situation for the predictable future is simple average equity returns growth compared by means of succeeding years in the 1990's of double-digit growth. Nevertheless, a number of sectors as well as regions will carry on to outperform others... The last prolonged bear market (the period in which prices fall) in US equities started in February 1966 moreover lasted till August 1982. The Dow Jones index value in February 1966 was 995 as well as 16 years afterward it stood at 777. So several investors who stayed completely invested in an average portfolio of shares in this period lost 22%. However over this time span there were four periods in which equities qualified extremely strong rallies which boosted the Dow by 32%, 66%, 76% and 38% respectively. According to a study of University of Michigan, an investor who stayed in the US stock market during the entire 30-year period from 1963 to 1993-7,802 trading days-would have had an average annual return of 11.83 %. However, if the investor missed the 90 best days while trying to time the market, the average return would have fallen to 3.28% per annum. Work cited www.investopedia.com/articles/fundamental/103002 retrieved on November2nd 2007 www.investopedia.com/terms/f/futuresmarket retrieved on November 2nd 2007 beginnersinvest.about.com/cs/marketanalysis/a/020301a.htm retrieved on November 2nd 2007 http://economics.about.com/cs/stockmarket//stock_recession_2.htm retrieved on November 2nd 2007 linkinghub.elsevier.com/retrieve/pii/S0264999304000355 retrieved on November 2nd 2007 dict.die.net/trade retrieved on November 2nd 2007 http://en.wikipedia.org/wiki/Stock_market retrieved on November 2nd 2007 Appendix Read More