How does a bull market affect the economy?

Trying to understand the impact of a bull stock market on the economy can present some chicken-and-egg dilemmas – where does correlation stop and causation begin? One belief commonly held by many consumers, investors and some market analysts is that a rising stock market is indicative of a progressing economy. Even if this were true, it's difficult to know whether the rising stock market actually affects economic growth or if it is one of the side effects of a healthy and productive business environment.

Some speculate that an improving economy leads to larger consumer spending, more equity investments and stock values that rise in accordance with an increase in companies' intrinsic values. This entire argument presupposes that consumer confidence and aggregate homogeneous spending increases actually drive economic growth. This still doesn't necessarily show that a rise in stock market prices leads to appreciable economic improvements.

Taking this argument at face value leads to some significant empirical problems, however. The record stock market gains in the late 1990s or the mid-2000s were subsequently followed by bursting asset bubbles. This probably does not mean that rising stocks lead to economic decline.

It is more likely that bear stock markets do not cause recessions, but that they are instead just side effects of a fundamentally unhealthy economy. In the same light, bull markets probably have limited abilities to positively impact underlying economic fundamentals.

Bull markets can arise from a shift in trading strategies, perhaps by investors pursuing higher growth assets. Stock prices tend to rise during periods of inflation when more dollars are pouring into the markets, independent of real economic growth. An increase in savings could lead to fewer purchases of consumer goods and more money invested in the stock market, pushing stock prices higher. It is fairly clear that there are limits to the correlation between economic health and stock markets.

If, either through accident or improved investor decisions, a bull market arose and an unusual amount of the additional investments went to very healthy and productive companies, then those companies would be able to expand operations, hire new employees and innovate. In these circumstances, long-term economic fundamentals would be improved.

The strongest link between the stock market and the economy is that, in the aggregate, increases in available credit and the circulation of money boost the gross domestic product (GDP) and the stock market simultaneously. This still does not necessarily mean that the economy is healthy, nor does it represent any causality between stock prices and economic growth.

Economies grow when productivity and efficiency increase, consumer goods become more available to larger groups of people and when people can subsist while still saving money. Saved money increases the capital stock (which the stock market uses), and future investments towards productive ends are possible.