Rising stock markets boost economy

Stock market closing a Preliminary data points to resilient economic growth in the US of 2.8% in the third quarter. In the last 12 months, GDP grew 2.7%, while the S&P 500 appreciated 35%.

The US economy remains relatively robust despite the persistence of high interest rates for two years. Remain restrictive both long-term interest rates, such as the yields on the 10-year (4.30%) and 2-year (4.20%) U.S. Treasury notes, and short-term rates, such as the Fed Funds Rate, between 4.75% and 5%. Between late 2009 and 2021, the US 2-year sovereign yield was consistently priced below 1%, with the exception of periods between 2017 and 2019 where average values ??fluctuated between 1.50% and 2.50%. Despite this context of high interest rates, the US stock market is experiencing a period of strong appreciation, driven by Artificial Intelligence (AI), reaching successive historic highs. Since the end of October last year, the S&P 500 has gained more than 40%.

Some predictive indicators of economic development, statistically relevant for anticipating recessions, have been pointing to a possible economic contraction for some time. Among these, the Sahm rule, the leading indicators of the economy (Leading Economic Index, LEI) and the US Treasury bond yield curve stand out, although it currently no longer presents a completely negative slope, now assuming a more close to a "U”. However, stock markets remain strong, recording consecutive highs, boosting the economy. Economic growth has also been supported by expansionary US fiscal policy, marked by consecutive fiscal deficits. In 2024, public accounts recorded a negative balance of 6.3%.

Rising stock indexes such as the S&P 500 have supported the US economy in several ways, both directly and indirectly. In the last 12 months, the significant appreciation of stock markets has had a positive impact on the economy via the wealth effect, providing families that invest in stocks directly or through pension funds or investment funds with greater financial security, stimulating the consumption of goods durable (like cars and houses) and non-durable (like leisure). Consumption is the most important component of US GDP, accounting for 70% of GDP. But it's not just consumer confidence, there is also increased investment by companies in new infrastructure, innovation, or greater production capacity, driving economic growth. It also favors financing via the issuance of shares (when share prices rise, the cost of capital for companies decreases), and promotes mergers and acquisitions. Companies also benefit from a greater debt capacity, dictated by the increase in the companies' market value, allowing them to obtain loans under more favorable conditions. This cycle promotes job creation and increases tax revenues, preventing an even larger budget deficit.

In short, the wealth effect mainly boosts consumer and business confidence, facilitates cheaper access to capital, supporting consumption, investment and, consequently, economic growth. But this wealth effect can have a less positive side, if it is not balanced, because when people feel richer they can leave the job market earlier, reducing the country's workforce and productive capacity (if innovation does not compensate ), culminating in a drop in production, increased inflation and economic imbalances, reversing a virtuous circle into a harmful vicious circle. Furthermore, if the significant investment in AI does not have the expected return, stock prices may undergo a considerable correction.

Paulo Monteiro Rosa
Senior economist at Banco Carregosa