The Influence of the Strong Economy on Financial Markets

In the financial system funds flow from those who have surplus funds to those who have
a shortage of funds, either by direct, market-based financing or by indirect, bank-based finance.
The former British Prime Minister William Gladstone expressed the importance of finance for
the economy in 1858 as follows: "Finance is, as it were, the stomach of the country, from which
all the other organs take their tone."
Financial markets provide for the efficient allocation of resources within the economy.
Through organized and regulated exchanges, financial markets provide participants with some
assurance that they will be treated fairly and honestly. The financial markets provide businesses
and governmental entities access to capital. They also provide employment to many thousands of
individuals who work in the financial industry.

The contribution of financial markets in this area is a necessity for maintaining the
competitiveness of an economy:
1. Speculation and Expectation
Speculation and expectation are integral parts of the financial system. Consumers, investors and
politicians all hold different views about where they think the economy will go in the future and
that effects how they act today. Expectation of future action is dependent on current acts and
shapes both current and future trends. 
2. Supply and Demand
Supply and demand for products, services, currencies and other investments creates a push-pull
dynamic in prices. Prices and rates change as supply or demand changes. If something is in
demand and supply begins to shrink, prices will rise. If supply increases beyond current demand,
prices will fall. If supply is relatively stable, prices can fluctuate higher and lower as demand
increases or decreases. 
Economic Factors
1. Interest Rates
Interest rates are one of the most important sets of numbers across the entire economy,
including the stock market. Interest rates are set by the Federal Reserve as a way to make
borrowing money more or less expensive, and in the process keep currency inflation to within an
established target rate.
2. Inflation
Inflation is the rate at which a currency devalues each year. inflation rates have a number of
effects on the economy that can be hard to tease apart. Interest rates that are too low can shake
consumer confidence, which hurts businesses, while interest rates that are too high can make it
too expensive for consumers to purchase goods. High inflation is particularly bad for businesses
because it also devalues their monetary gains.
3. Politics
Politics, both domestic and international, can have a large influence on the stock market.
Typically, investors see one candidate as better than the other as offering better policies for
increasing corporate and shareholder profits or for improving the overall economy, which can
cause large multi-day spikes in the way the market is trending.
4. Foreign Markets
Typically, reactions from foreign market movements are short-lived – on the order of days to
months – and will not affect long-term investors, although day traders and short-term investors
will need to be wary of this economic factor.
 5. Unemployment Rate & Jobs Reports
The relationship between unemployment rates and the stock market can be complex. While it
might intuitively seem as if lower unemployment is good for the economy and therefore must be
associated with a bullish stock market, that is not always the case. Instead, when unemployment
is low, investors tend to be more willing to pay high price-to-earnings ratios for companies,
which can turn bearish since high valuations are associated with below average forward returns.
6. Economic Growth & Projections
Reports of economic growth and projections of future growth are a frequent trigger for intra-
day and multi-day swings in the stock market. In the same way that corporations need to perform
on both reported profits and projected profits during earnings reports, economic growth
announcements typically need to meet investor’s expectations of both current and future growth
in order to cause a significant uptick in stock prices. While disappointing economic outlook
reports may not have much of an effect in a bullish market, they can have a significant effect in
volatile or bearish market conditions.

What then should emerge market countries do to promote strong financial sectors?
Governments need to put in place clear and consistently applied regulatory frameworks and
to maintain strong financial supervision, while reducing unnecessary legal and regulatory
impediments to the smooth functioning of these markets.
 Advanced economies have been the development of thriving markets in mortgages
and consumer credit.
 Avoid the temptation to direct commercial bank credit or excessively intervene in
product design.
 A strong supervisory framework is fundamental.
 Competition between institutions is important, too.
 Improving the legal environment would also clearly contribute to progress.
 Adequate protections for investors and borrowers should be put in place.
 Emerging economies can also benefit from better truth-in-lending rules and greater
financial education.
 Development is corporate bond and equity markets.
 Derivatives markets can make an important contribution to risk management and risk
diversification.