How the Stock Market Affects Small Business

Financial Markets, Recession, and Small Business Action

There is still a panic going on in our economy and our society right now. We're in a deep recession and it's scary to individuals and business owners alike. Most business is down with sales low and profits lower. Investors are scarce or non-existent. It's hard or impossible for small businesses to get a bank loan. If you watch cable news, all you hear all day long is bad economic news.

What has happened and has does it really affect you as a business owner?

Let's take a look at the history.

Recent History of the Stock Market

In July of 2007, the Dow Jones Industrial Average (DJIA) closed, for the first time, at 14,000, a record high. The Dow is composed of 30 stocks of the major corporations doing business in the United States. It is generally considered to be a barometer of the state of the stock market and the state of the economy. By October, 2007, the DJIA hit an all-time record above 14,000.

During March, 2009, the DJIA closed at a 12-year low at less than half that record high. A market that is going down is a bear market. Investors are obviously in a panic about their retirement portfolios, probably including you. Business is slow and everyone is hanging on to their money.

How the Stock Market Works

The first thing you should know is a little bit about the psychology of the stock market. There are two words that explain what moves the market - investor expectations.

When people and institutions who own stock hear good news about the economy, they buy stock because good economic news means corporations will be able to make and sell their products and jobs will be plentiful. Buying stock means the price of the stock will go up and so will the stock market and one of the key indicators, the DJIA.

However, when there is bad economic news, the opposite happens. Investors in the market get spooked and sell their stock. When there are more sellers than buyers because the sellers are afraid that the corporations in which they own stock will not perform as well as they hope, then the stock market goes down.

Think of all the bad economic news we have received over the past year. It started with the subprime mortgage crisis, moved to the collapse of the Wall Street investment banks and big insurance companies like A.I.G., and massive unemployment and job layoffs. No wonder the DJIA has fallen so far.

The Housing Crisis

Even before the stock market reached its high of over 14,000 in October of 2007, there was a crisis brewing in the U.S. housing market. Housing prices had already started to decline, but housing prices had been at historic highs for several years.

Banks had been making loans to individuals without the usual 20% down payment that had been traditionally required. They were also charging a higher interest rate for these loans to make up for the increased risk.

The loans were often adjustable rate mortgage loans (ARM). This type of mortgage loan does not have a fixed interest rate. Instead, the interest rate changes as market interest rates change.

Some of these owners of homes with subprime mortgages were having trouble making their mortgage payments. Homes were going into foreclosure.

By July of 2008, home foreclosures were picking up steam. In addition, we were dealing with record gas and oil prices with a gallon of gas selling at above $4 per gallon.

We were beginning to see that our economy was dropping into a very difficult economic time. Chances are, these challenges were affecting your own business. At this point, the DJIA dropped to around 11,000 from its high of 14,000.

The Stock Market and Retirement Plans

The stock market is an important indicator of economic health. So many more Americans now have money invested in the stock market than at any time in the past. Many business owners have funded retirement plans for their employees and themselves through purchases of stock for 401(k) retirement plans. Some small businesses have retirement plans like the SEP-IRA or the SIMPLE-IRA that they help fund for themselves and employees.

The DJIA has dropped to half the value it had in July of 2007. That means that retirement plans for you and your employees may have dropped in value by as much as 40% - 50%.

The Wall Street Crash

In September of 2008, it became evident that our economy was in worse shape than we knew. Financial institutions started to fail and Wall Street came down like a house of cards. The Bush administration had to "bail out" a number of banks and other financial institutions in order to keep them solvent.

The credit markets locked up and it became impossible to get a loan, for individuals and businesses alike. By November 20, 2008, the DJIA closed at 7552.29. There was then a modest rise toward 9000.00 by the first of 2009, but the market had just experienced its worst annual performance since the 1930s.

The Results

In the midst of all this, foreclosures of homes were rampant. Gas prices had moderated but were still high. No one could get credit. Home prices had declined 30%-40% but no one could sell a house and huge inventories of houses were on the market.

The American auto industry has been in trouble for a long time. The economic crisis just made it worse. Car sales dropped at the Big 3 automakers by 30%-50% and the auto industry needed and received a bailout in order to survive. We don't yet know if that bailout is going to work.

Unemployment rose to highs not seen in many years and job layoffs continued to plague the nation stretching from the automobile industry to the small business.

This is where we find ourselves economically. The federal government is putting a variety of plans into effect to try to stimulate the economy and repair the financial system. These plans will not work overnight. However, the first priority is to get the credit markets lending again. That is likely to be the first step that will help you as a business.

Don't give up! As some of the government plans start to work and businesses can get back on their feet, investor expectations will start to rise and as investors become more optimistic, the stock market will gradually start to go up.

It may take the stock market a significant amount of time to get back to the highs we experienced in 2007. However, the stock market is what is known as a leading indicator, which means its performance leads the economy. In other words, it should start rising before the recession is actually over. At this point, the retirement portfolios for you and your employees will start to recover.

There is no doubt that we are in a deep economic recession and no reason to give false hope.

But, small businesses drive our economy. You and your business will be very important in getting the U.S. economy back on track even though it will take time and effort.

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