Assume that in January of 2015 the congressional budget office (CBO) released a
ID: 2744631 • Letter: A
Question
Assume that in January of 2015 the congressional budget office (CBO) released a report predicting that our economy would grow by 1.95 during the 2016 calendar year. assume that one year later the CBO releases an updated version of that same report that predicts our economy would grow by 1.57% during the calendar year. a. Should stock prices move up, down, or stay flat upon the release of the revised figures in January 2016? explain your answer in detail. Assume that this revision is a surprise to the investor community. b. If, instead, most investors had already revised their estimates prior to the updated CBO report, what would the response to be release of the 2016 CBO report? c. How would stock prices differ, a week after the release of the revised CBO report, between the two hypothetical scenarios ( surprised vs. informed investors)? Explain why.
Explanation / Answer
Answer a :-
The effect of economy growth on stock market mostly based on the two factors , first is financial conditions and other is consumers confidence. The stock market always tries to predit the future certainity and uncertainity and on the basis of that the Investor put or withdraw their money from the market. Gross Domestic product figure is the most prominent figure in order to describe the growth of the economy. Gross domestic product figure shows the sum total of the goods and the services produced within the geographical boundries of the Country. GDP can be described as the sum total of the economic activity of the country in a perticular period of the time . GDP can be explained by the following formula
GDP = Consumption ( both private & government ) + Investment + Export - Import.
From the abve eqution, we can easily understand that the growth of the economy is depends on the consumption and Investment .To make the discussion lighter, we assume that country do not have any foreign transation - no export no imports. If the consumption is more than it become a oppurtunity for the business community to expend their manufacturing activity and supply more and more product in the market in order to earn more and more profit . More profit will have the positive impact on the share price of the company hence lead to the upward price movement of the stock market . More consumption leads to more Investment - More investment leads to more supply - More supply leads to more profit - More profit utlimately leads to higher share prices in the stock market.
In the above suitation the estimated economic growth figure has been revised by the CBO is 1.57% instead of 1.95%. In this case, the stock market will move down as soon as the market receive the information because , the price of the share in the stock market has been drived by discounting the profit earnes by the companies if the economic growth will be 1.95%. As soon as the market receive the information of the reseived growth rate of 1.57% the profit figure of the companies will be adjusted with the profit should have been if economic growth is 1.57% ultimately lead to downward movement in the stock market.
Now , On the first line of the answer we have discussed that the movement of the stock market is depends upon the consumers confidence . The stock market always discount the future. If in the given suitation , the downward revision of the economic growth figure is a surprise to the Investor community , which shaken their confidence and they start reducing the position in the market and ultimately a sharp fall in the stock market. This is also called as panic selling.
Answer b .
If the investor community had already revised their estimate prior to the release of the CBO economic data then the stock market does not react to much in that senario because the Investor community already adjusted their portfolio based upon their revised estimate . The relese of economic growth figure by CBO is just only act as a confirmation to their adjustment. Thus , In this case the stock market will be flat.
Answer c.
In case of surprised scenarion :- As soon as the panic selling by the Investor community ends the stock market tries to consolidate itself at a certain level of the point. This consolidation takes time one weeks or ten days . Due to large amount of selling presure the stock market fells sharply but after certain point of time the Investor releases the rationalities of the fact and figure with the fundamental strength and future growth of the economy and try to consolidate their position in the market which in turn leads to the recovery to certain extends and then tries to sustain this recovery and wait for another events to have a rection on it.
In case of Informed scenario :- As the Investor community already adjusted their portfolio the market will be trading flat . After certain period or after one week the Investor community again tries to find out the fundamental strength and future prospect of the economy and if they find positive indication then they will again start buying in the market lead to the upward movement in the market or viceversa.