Stock Market Trends and the Prospective Level of Economic Activity

Stock market trends are a barometer of the overall level of economic activity. The author suggests that there should be a connection between stock market trends in year T and the real rate of GDP growth in year T+1. Research has confirmed this hypothesis. There is a positive correlation between the stock index return in year T and the real rate of GDP growth in year T+1. Expectations involving the future real rate of GDP growth are important to stock market participants. The same applies to expectations about changes in this rate in relation to the previous period. Periods of economic recovery, with an improved real rate of GDP growth, are usually preceded by a much better behavior of the stock index than periods of economic slowdown, when the real rate of GDP growth deteriorates. The actual relationship between stock market trends and the future real rate of GDP growth depends on the role of the stock market in the economy. Mature markets are generally characterized by a greater positive correlation than emerging markets. Research into the nature and intensity of the relationship between the stock index return and select GDP constituents indicates that stock market participants try to predict the future level of economic activity. Among individual factors, market participants pay special attention to the prospective growth of imports, exports and investment expenditure. The research incorporated statistical and econometric methods as well as the theory of probability