Macroeconomic Indicators on Stock Market â€Myassignmenthelp.Com

Question: What Is The Impact Of Macroeconomic Factors On The Stock Market? Answer: Introducation For investors entering the stock market, assessing the financial statements of companies is not enough. There are several other macroeconomic factors that also influence the prices of stocks. These factors affect the stock market mainly via different channels and hitting on the supply and demand chains. Some of these factors include inflation, GDP growth rate, demographic changes or also monetary policies of the central bank of countries. Just like all other goods and services the theory of demand and supply also applies for stock markets. As we know, according to the theory of demand, , a fall in demand of a particular good shall decrease its price whereas an increase in demand shall increase it price (Lipsey et al., 2011). Similarly, when the supply of a good increase, its price falls whereas, a decrease in supply would increase its price. In the stock market, the same law applies. When demand for stocks increase, its price increases and vice versa whereas when supply of stocks fall its price increases and vice versa. As we see below, in the first diagram we see the shift in demand cause, which raises/lowers the price level of stocks. In the second diagram, shifts in the supply curve result in rise or fall in price. Thus in reality when a company lands up with low earnings the demand for their stock may go down which changes the equilibrium between buyers and sellers. This causes the future buyers to demand for a discount in stock price and hence, many sellers are motivated to accommodate. As more sellers exceed the number of buyers, price falls. The factors which affect the equilibrium of demand and supply are many among different macroeconomic factors. We shall discuss further about each of such factors. Demographic trends or transition also turn out to be a factor which can have major impact on stock markets. In the 21st century, one of the major demographic phenomenons is population aging. This aging of the population is occurring as due to high life expectancy and low fertility rates, the proportion of the population aged 65 and above is continuously increasing. The major proportion of the working age population which is moving towards retirement constituted of the percentage investing the most on stock markets. As these persons retire, the overall demand for stocks will fall and cause changes in the equilibrium. The consequences of demographic transition is still under research and studied by several analysts and economists. Many researchers also reported that population aging will not have significant effects on the financial markets (Bakshi et al., 2000). Gross domestic product which is the total amount of final goods and services produced in an economy may also affect the stock market, but its effects are still debatable among economists. GDP or GDP growth rate is also a measure of a countrys economic performance (Samuelson et al, 2000). Theoretically it is expected that a country which is healthy and growing, hence, with higher GDP is expected to cause higher demands in the stock market and also higher supplies, and with better stock market returns. At such situations when the country is growing companies or businesses also enjoy higher earnings and profits which attract more investors. On the other hand, lower GDP values may also have a negative impact on the stock market considering the aggregate demand of the economy falls. This theory is based on the fact that GDP is the aggregate of consumption, investments, government consumption and net exports. Thus any acceleration in these factors shall also have a positive impact on corpo rate sales. Higher earnings of corporate will lead to a higher earnings per share (EPS) which will translate into higher market returns (Levine et al, 2000). Though theory says this, reality is seen to be different in the short run at least. For instance if we consider the 2008 Financial crisis, we saw the stock market returns fell by 40 to 60% but that was not translated into a fall in GDP by 50%. But the theory is more justified in the longer run, where we see that many companies like United States have seen a rising trend in the stock market returns since 50 years or so which was because the country also saw higher levels of GDP and rising economic growth over the same period. The relationship between growth rates and stock markets are still found to ambiguous and still researched upon. Inflation is another factor which also has its effects on stock markets. It is the rate at which prices of goods and services rise over a period. Hence, higher rates of inflation are linked with higher costs of producing goods and services and in such a situation the company faces a cost constraint where it has to produce less and also lay off workers. At these situations, investors also perceive companies to hold back on spending which gives a negative outlook to investors and also the demand for the stocks fall. Thus, with higher costs there is also a fall in revenue, resulting inflation to have adverse effects on the stock market. When the economy faces the threat of an escalating inflation, the central bank of the country tries to control it through interest rates. It raises interest rates and expects investors to allocate their cash in fixed income instruments and hence, driving away excess liquidity from the system. Less liquidity in the system implies less speculative demand for goods and services which shall slow down the rise in prices. The rise in interest rates shall attract investors because of higher risk free return which is bearish for the stock market, as it reduces demand and hence reduces stock prices. It also happens that when higher inflation is expected, the uncertainty tends to increase the risk premium leading to higher expected returns from the stock markets (Feldstein, 2000). The opposite of inflation is deflation when prices fall. It may be thought that deflation may not be a problem for stock markets, but what happens is the opposite. Deflation acts as an indicator representing a weak economy and hence, drives away investors from investing in stocks. It implies companies earning smaller amount of profits, leading them t shrink as it lays off workers, reduces employee wages, cut on production costs or may even close production facilities. The prices of equity fall as people sell off investments which do not offer good returns anymore. As we saw above, in times of high inflation or deflation, the central bank steps forward and use various monetary or fiscal instruments to siphon off liquidity from the system. At these situations the central bank opts for various monetary and fiscal policies which may be expansionary or contractionary in nature. Expansionary policies of the central bank are when it injects money into the system whereas the opposite holds for contractionary policy. Fiscal expansionary policy leads to expansion of aggregate demand and consumer spending as with higher government expenditures and with tax cuts the liquidity in the system is increased (Mankiw, 2015). This increased aggregate demand shall increase consumption and investment which is translated as higher earnings for companies leading to higher EPS and thus, greater demand in the stock market (Duffy et al, 2013). On the other hand, expansionary monetary policy occurs when financial conditions are improved instead of demand. As we mentioned before, just like when central bank increases interest rates which leads to a fall in demand in the stock market, a decrease in interest rates pumps up profits as demand increases and leads to rise in prices. This happens in case of expansionary monetary policy, which improves the balance sheet of companies. Thus we saw, how via different channels of macroeconomic factors, hits the supply and demand of stock markets which brings changes in the equilibrium in the market and what follows is a fall or rise in price. A new investor in the market should investigate the current situation of the economy as well as expectations of changes in several macroeconomic factors which shall indirectly affect stock markets. References Duffy, D, Filis, G Chatziantoniou, I. (2013). Stock market response to monetary and fiscal policy shocks, JEL Bakshi, G Chen, Z. (2000). Baby boom, Population aging and capital markets. The journal of business. Feldstein, M. (2000). Inflation and the stock market, https://www.nber.org/chapters/c11335.pdf [Accessed 12th May 2017] Levine, R Zervos, S. (2000). Stock markets, banks and economic growth. The American economic review. Samuelson, P. Nordhaus, W. (2010). Economics. New Delhi: Tata McGraw Hill Mankiw, G. (2015). Macroeconomics. New York: Worth publishers Lipsey, R. Chrystal, A. (2011). Economics. New Delhi : Oxford