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How stock market volatility could impact the economy

Stan Alcorn Oct 16, 2014
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How stock market volatility could impact the economy

Stan Alcorn Oct 16, 2014
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The stock market jitters of the last week have numerous causes: ebola panic, Europe’s economic slump, the settling in of weak economic growth and the imminent end of the Fed’s bond-buying program. 

The effects, beyond temporary shifts in stock prices, are less evident. But stock market volatility can have a real-world impact.

“In research I’ve looked at 19 previous stock market jitters in the U.S.,” says Nicholas Bloom, professor of economics at Stanford University. “These are normally followed by nasty contractions.  And the reason is reasonably easy to see.”

Bloom says that volatility can lead to uncertainty, and when  individuals and businesses are uncertain about the future, they put off big purchases.

“So, for example, firm investment tends to drop very heavily. If you look at consumers you see it’s consumer durables that drops a lot. So things like new cars, furniture, clothing,” he says.

And a lack of investment, whether it’s by companies or consumers, has a real effect on the economy.  But before you lock up your credit cards, Bloom says the volatility we’ve seen this week is all smoke and no fire–so far. 

First, consider stock prices.

“I think at this point, if, say, we were lucky and things stopped today, didn’t get any worse, probably not too big of an impact,” says Russ Kinnel, director of mutual fund research for Morningstar. 

 Kinnel says shares have lost–at most–the gains from one year of a five year rally.

 Then consider the stock volatility. One common measurement is the VIX.

“It’s risen by about 50 percent over the last week,” says Bloom. “Historically big jumps that I’ve examined have a VIX increase of more than 100 percent.  They also lasted around a month.”

In other words, if the current volatility doesn’t last, its effects shouldn’t linger either.

“After it’s out of the news, you know, people’s perceptions and sentiment tend to shift back,” says Gary Thayer, macro strategist at Wells Fargo. “And that’s I think what we’re likely to see here.”

 

 

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