The advantages of investing in stocks revolve around their superiority over other assets in terms of providing returns in the long-term and their high liquidity. However, considering the different factors affecting stock prices and the overall performance of the stock market, investing in stocks has disadvantages that rest on risks.
What Moves the Stock Market: The Factors that Affect the Prices and Values of Stocks
1. Factoring in Supply and Demand in the Movement of Stock Prices
Like in most things that are traded in a particular market such as commodities to include oil and precious metals, currencies and cryptocurrencies, real estate, artworks, and even non-fungible tokens, one of the factors that affect stock prices is the level of supply and demand. The level of investor demand is a specific crucial factor.
There are a limited number of stocks and shares offered in the market by publicly-traded companies. The number of shares a company is authorized to sell is determined at its creation. It can only be increased or decreased through a vote by the relevant shareholders.
Stock prices tend to rise when there are more buy orders than sell orders. Prices decline when sell orders outnumber buy orders.
It is also important to stress the fact that demand in the stock market is determined by five more specific factors. These are the earnings of companies, the earnings of individual and institutional investors, the overall economic health, expectations among investors and analysts, and prevailing emotions or public market sentiments.
Prices rise when all of these five are positive and fall when all are negative. Of course, the level of supply and demand is not enough to understand what moves the stock market.
2. Macroeconomic Factors Affecting Stock Market Performance
The status or health of the economy specifically affects the stock market in two ways: either because it cripples demand for the goods and services produced by publicly-traded companies, thereby affecting their earnings, and signals investors to either refrain from investing or channel their investment toward low-risk or moderate to conservative options.
More specific macroeconomic factors such as interest rates, the rate of inflation, the prices of input commodities such as oil and gas prices, the level of unemployment, and fluctuations in the value of a particular currency in the foreign exchange market.
To understand the factors above better, take note of the following:
• Interest Rates: There have been instances in which high interest rates result in low stock prices. The two have an inverse relationship. High interest rates mean that companies have higher costs of borrowing and consumers have less access to credit to make new purchases. These two scenarios affect several companies in specific industries and sectors while also affecting the health of the economy.
• Inflation Rate: High inflation rates prompt a government through its central bank or monetary authority to raise interest rates to ease the prices of goods and services. Hyperinflation effectively devalues a particular currency and weakens consumption activity in a particular economy.
• Commodity Prices: Certain commodities are important production inputs. For example, an increase in the prices of oil and gas increases the manufacturing and transportation costs of several companies, thus affecting their earnings. However, in the same example, these increases also increase the attractiveness of oil and gas companies.
• Unemployment Rate: High levels of unemployment in a particular economy result in lowered consumption activities that affect the earnings of companies and overall economic productivity, thus suggesting that it would not be wise for investors to invest in stocks traded in affected markets.
• Forex Performance: Fluctuations in the value of a particular currency affect companies involved in exportation and importation. A currency weak against a foreign currency increases the costs of importing raw materials for production and exporting products to a foreign country or traded in the global market.
A poor-performing economy is fundamentally accompanied by crashes in the stock market in which stock prices go down as a result of massive sell orders.
Several instances of financial and economic crises such as the dot-com bubble of the late 1990s, the 2007-2008 Financial Crisis that started in the United States, the European Debt Crisis, and the economic impacts of the COVID-19 pandemic demonstrated instances of notable stock market crashes that wiped out billions of dollars of wealth.
3. Social and Political Conditions in a Particular Market and Country
The political climate and social conditions in a country are also considerable factors that affect stock prices and the overall performance of the stock market. Prices of stocks tend to go down if there is political uncertainty or prolonged sociopolitical unrest because either of these two situations can become a precursor to an economic crisis.
Furthermore, threats of civil war, the presence of destabilizers and separatists, even the threat of war with foreign countries, as well as negative public sentiment regarding their government or perception of poor and weak governance can drive down stock prices.
Investors do not want to risk investing in companies that operate in countries that are under social and political distress due to uncertainties.
Opinions and directives from foreign superpowers, supranational organizations, and non-state actors in the international community about a particular country can also influence the investment decisions of individual and institutional investors.
The foreign policy of a foreign country and the different types of economic sanctions it imposes can also negatively affect the stock market of a target country. Sanctions limit the participation of local companies in global trade and undermine economic growth prospects.
4. Level of Participation of a Country in Economic Globalization
Economic globalization has paved the way for countries and their respective homegrown companies to partake in global trade. One of the benefits of globalization is that it has allowed the cross-border expansion of businesses. Furthermore, it has also enabled economies to grow by maximizing their competitive and comparative advantage.
Countries that are well-integrated into the global economy tend to have well-performing stock markets. Companies in these countries have a wider customer reach as opposed to their counterparts that operate in limited geographic markets.
In addition, because of the economic gains that come from high levels of participation in globalization, investors are naturally drawn to invest in companies that have the highest potential to expand further and maintain or grow further their profitability.
A downward shift in the level of participation in the global economy can be indicative of protectionist economic policies and medium-term to long-term economic problems.
Several companies listed in stock exchanges that have a global consumer base or business presence tend to have robust stock market performance. Examples include Apple and Amazon in the United States and Alibaba and Tencent in China.
However, it is also important to note that economic globalization exposes companies and economies to more risks. For example, the Evergrande Debt Crisis demonstrated how a Chinese real estate company can affect stock markets outside China because of their level of exposure to companies, as well as industries and sectors connected to the China Evergrande Group.
Risk exposures were also demonstrated during the housing crisis that started in the U.S. and ended as the 2007-2008 Financial Crisis, and the Eurozone Debt Crisis.
5. Specific Company-Related Factors and Their Impact on Stock Prices
The performance of a company can also determine the price of its stocks and the sentiments of the investors. A publicly-traded company typically reports its quarterly earnings and the particulars of its financial and operational performance. Investors that use fundamental analysis reference these reports to guide their investment decisions.
Companies that cannot meet the demands or previous assumptions of their investors often experience a decrease in their stock prices. These prices tend to rise if companies succeed in meeting or exceeding the expectations of the investors.
Investors are almost always willing to risk investing in a particular company that has been consistent in demonstrating above-average earnings growth and cash flow.
Ongoing projects and future plans of a company can also influence the willingness of these investors to purchase its stocks. However, not all projects and plans are met with optimism. For example, when Facebook changed its name to Meta Platforms and announced its plans to introduce the so-called metaverse, the price of its stock decreased.
Some of the more specific company-related factors that affect the stock price of a particular company include financial ratios such as debt-to-equity ratio, market capitalization and market valuation, and the performance of its product portfolio.
Furthermore, internal events such as changes in management and its organizational structure, mergers and acquisitions, horizontal and vertical integration, the status of its supply chain, response to current events and sociopolitical leanings, and social responsibility programs can either encourage or discourage investors.
The dire situation of a particular company can affect the stock prices of companies exposed to its value chain. The Evergrande Debt Crisis is a prime example.
6. Emotions and Speculation as Factors Affecting the Stock Market
Investing has an emotional dimension for the simplest reason that people are prone to make decisions based on the state of their mind and in response to current events or the influence of their peers. Overall investment sentiments driven by human emotions are important factors that affect the performance of the stock market and the prices of stocks.
Note that there are two emotions that play a role in investment-related decisions. These are fear and greed. Negative news about a particular company or the overall state of the economy generates fear. The response to this emotion is asset liquidation.
Fear-driven investors liquidate their stocks through sell orders to sit on cash and avoid risks. The pervasiveness of negative news and poor economic outlook can drive mass hysteria and result in large-scale dumping of stocks. The psychosocial mechanisms behind this phenomenon are also similar to instances of panic buying and bank runs.
Remember that liquidation of stocks transpiring in large numbers and across industries and sectors will drive down stock prices due to the overabundance of supply.
On the other hand, greed transpires through positive news and a favorable outlook. Some even respond to sudden upticks in the price of particular stocks. Greed-fueled investors feel the need to capitalize on a possible opportunity by purchasing more stocks.
Massive instances of buy orders could result in upward movements in the stock market. However, the market is self-correcting. Stock prices will eventually go down the normal levels, thereby resulting in losses for investors who purchased stocks at a premium.
Speculation is another human factor affecting the stock market and stock prices. It transpires when there is a positive outlook about a particular stock or the entire market.
The phenomenon results in large-scale buy orders of stocks. However, because of its pros and cons, this scenario can result in sudden upticks in stock prices that will eventually ease out due to market self-correction. Furthermore, over-speculation can instill either fear or greed among other investors, thereby resulting in unnatural price movements in the market.