How Stock Prices Influence the Real Economy


The real economy must be concerned with the value of its representatve stock for several reasons.


1. Raising capital:

Corporations can raise capital by selling pieces of ownership, called stock, to the public. This process can generate large amounts of cash that can be used for a variety of purposes.

When Plantronics, Inc. (NYSE symbol: PLT), a leading manufacturer of high-tech telephone headsets, "went public" in January 1994, it issued 3 million shares of stock that raised $37.5 million. Plantronics used most of the proceeds to pay off accumulated debt and a senior note offering. In addition to paying off debt, companies will use the capital from "going public" in a variety of ways, including building new factories, purchasing equipment, increasing advertising and marketing budgets, hiring new workers, or researching new products.

When a corporation's stock is issued for the first time it is called an initial public offering (IPO) and it is traded in the primary market (ie. stock brokerage firms). Later, when the stock is resold to other investors, it is sold on the secondary market, such as the Toronto Stock Exchange (TSE) and the New York Stock Exchange (NYSE).


2. Distribution of investments:

Even corporations need to invest. All companies are well advised to invest their capital reserves in a variety of other holdings, so as to maintain the financial security and longevity of their enterprise. If the stock market falls, the real economy experiences a loss for two reasons:

  1. Corporations will experience a paper loss in terms of the value which their holdings decreased. It could be that the company required the value associated with these holdings to expand or maintain their business.

  2. Consumers will also experience a paper loss. It could be that these consumers had plans to sell their stock and spend the proceeds in the market place. This lack of spending will invariably influence corporate sales and profits.


3. Maintaining control of its stock:

We must never forget that stock represents the ownership of a company. If the price of the stock falls, the price of ownership, and thus corporate control, also falls. As stock prices fall, a company becomes more and more susceptible to hostile takeovers. In some cases, a company's own board of directors may spend large amounts of its own capital reserves just to buy its own stock in order to protect itself.


4. Support of its own domestic currency:

The value of a company's domestic currency will invariably have an impact on its ability to do business.

Interestingly, the value of Canadian currency will be influenced by the stock market. Stock on the T.S.E. must be purchased in Canadian dollars. The more stock that is purchased, the greater the demand for Canadian money. The more stock that is sold, the lower the demand for Canadian money.

Thus, a strong Canadian stock market will support a strong Candian dollar... and a strong dollar will enable domestic corporations to purchase imported goods at lower prices.

An interesting reversal that should be noted is the fact that a weak Canadian dollar will often assist the Canadian export industry, as it will mean that Canadian exports are less expensive for other countries to purchase.