Future Expectations

Every stock that you own is an ownership stake in the future profits of some business. Naturally, these future profits may not be realized or may fall short of expectations which could lead to decline in the stock’s value. But what do these profits depend on? Mainly two things : the profit margin and the total revenues earned by the firm. You multiply them and voila, you have the profit. Now imagine that you combine all the publicly traded companies in America into one giant corporation. The performance of the “stock” of this entity is approximated by well-known indexes like the S&P 500, the Dow etc. We call this thing the “stock market” or just the market. We will get to bonds and other asset classes later, but similar rules apply there.

One reason why thinking about the market as a whole is useful is because the total sales of this construct correspond approximately to the Gross Domestic Product (GDP) of the United States. In other words, you could expect the total market sales to grow approximately at the rate of growth of the economy as a whole. It’s nice to be able to link the market to something in the “real economy”!

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