Stock markets and the real economy – any link?

01 March 2013

By Yih Lin Teh and John Hawksworth, Chief Economist

From November 2012 to the end of January 2013, major stock markets around the world experienced relatively strong gains – in marked contrast to negative GDP growth in most of the major advanced economies in Q4 2012.

What should we read into this? If stock markets are reliable leading indicators for the real economy, this rally might be expected to feed through into stronger business and consumer confidence and wealth, which in turn could boost real economic growth prospects during the first half of 2013.

But how reliable is the stock market in predicting future growth? To test this, we looked at the past relationship between share price movements and indicators of the real economy in the US and the UK over the past 40-50 years. The table below summarises our findings, which are set out more fully in a recent PwC research paper.

Table 1: Summary of findings
  UK GDP UK unemployment US GDP US unemployment
Strength of stock market price effect Moderate / weak Weak Strong Strong
How long does it take stock market price changes to have significant impact? 3 quarters 1 year 1 quarter 1 quarter
Momentum effects Low Low High High
Importance of trend High Low High Low / moderate

Our key finding is that the relationship between stock market prices and real GDP growth (or changes in the unemployment rate) is reasonably strong for the US, but much less so for the UK. This can be explained by a number of factors:

  • Effect of stock markets on consumer spending: in the US, it is much more common for households to hold shares directly which leads to stronger and more visible wealth effects. In the UK, shares are primarily held by institutional investors such as pension funds and life insurance companies. This reduces how directly UK consumers experience and respond to movements in stock markets.
  • Channels through which stock market changes impact the economy: UK stock market prices take a longer period to feed through to the economy (3 quarters for GDP and a year for unemployment). This could be because the primary channel for stock market movement to impact the UK economy is through business confidence and subsequent investment decisions, which will take longer to come through than consumer spending changes, which are more important in the US.
  • Influence of the global economy: the UK stock market includes many international companies, whose earnings depend on the global economy more than that in the UK. Hence, the link between the UK stock market and its domestic economy is likely to be weaker than for the US, which makes up a much larger share of the global economy and the global stock market.

We also found two other factors that drive changes in GDP growth and unemployment rates: momentum effects and the underlying trend rate of growth.

The momentum effect is the extent to which growth from one quarter feeds through to the next. We found that there are relatively strong momentum effects in the US economy, perhaps linked in part to the greater short term influence of the stock market, but these were much less evident in the UK.

The underlying trend growth rate is a key driver of quarterly GDP growth in both the UK and US (but is particularly dominant in our UK model). However, changes in the unemployment rate do not exhibit such a clear underlying trend (except much more weakly for the US).

So what does all this mean for short term growth prospects? For the US, it supports our view that growth may resume in 2013 after the pause seen in Q4 2012, boosted in part by the wealth and confidence effects from stock market increases since November. For the UK, we also expect the economy to return to modest growth in 2013, but this is due to factors other than the influence of earlier UK stock market rises, which we would see as reflecting increased optimism about the global growth outlook for 2013, rather than anything specific to the UK.

For further information, please see the full research paper at:

Yih Lin Teh:
Contact by email | Tel: 020 7213 5368

John Hawksworth:
Read profile | Contact by email | Tel: 020 7213 1650



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