If you are keen on investing, you should not be misled by the current profile of a company alone, you have also to be knowledgeable about various events that can take place and affect the company’s position in the stock market and the value of its shares and stock. Not only do economic changes affect stock prices, but other types of events such as political, social, cultural, etc. can have a strong impact as well. In today’s era of digital interconnectivity, the world has become a global village and a unified marketplace. Hence, any event taking place in one country or region can have far-reaching impacts that can be felt in every other country across the globe. In this article, let’s have a look at some examples of all major kinds of events that take place inside a country or internationally and understand the kinds of impact they can have on a nation’s as well as the global economy.
What factors affect financial markets?
The market which is constituted by corporates and all other business entities functions in a certain set of environments and is in constant interaction with them. Hence, changes in the environment will affect the financial status of any market. The environment could be economic, political, social, cultural, etc. An event could be understood as any change in an environment that is strong enough to have an impact on the stock market and share prices of companies. Let’s see some of the typical events that affect the stock market.
Impact of Monetary policy on the stock market
The monetary policy of any country can affect market prices significantly. The monetary policy concerns fundamentally controlling the money in circulation by the central bank of any country by adjusting certain interest rates. In India, the Reserve Bank of India (RBI) sets these rates as it plays the role of the central bank in India. It is called the Federal Reserve System in the USA. The monetary policy could well be the answer to the question, “What affects the stock market the most?” as it encompasses the entire economic profile of the country and contributes a sort of master effect to every monetary transaction that takes place.
So how does RBI policy affect the stock market? It’s simple to understand. When the interest rates are high, borrowing becomes less, which will affect the growth of corporations and pulls down the economy. And, what happens when interest rates are cut? The borrowing increases and the consumers and corporates will have more money in hand. It can increase prices and lead to inflation.
The best solution from RBI would be to strike a proper balance in the rates such that growth is encouraged and at the same time inflation remains in control. It is the responsibility of RBI to make sure that the impact of RBI policy on the stock market doesn’t affect the economy of the country negatively. The following are the main rates set by RBI:
- Repo rate: The rate of interest at which banks borrow from RBI is known as the repo rate. If it is high, banks will be discouraged from borrowing, which leads to less money in circulation. It can affect market performance. In the USA, it is related to the Federal Reserve System. The Repo rate in the USA as of July 31, 2020, is 0.15.
- Reverse Repo Rate: Reverse Repo Rate is also one of the macroeconomic factors affecting the stock market. It is the rate at which RBI borrows from banks. If it is high, the banks will be encouraged to lend money to RBI so that less money will be flowing from banks to other entities. This will again affect the economy and the market.
- Cash Reserve Ratio (CRR): This is the mandatory fund that the banks deposit with RBI. The more the cash reserve ratio, the less money remains with the banks. Such deficiencies will also affect the economy directly.
Another one of the major factors affecting share prices in the stock market is Inflation. Inflation is the term representing the increase in the prices of commodities and services in any market. The flip side is that the purchasing power of money suffers. In other words, money value comes down. This is what affects the stock market prices significantly. Inflation is usually measured using certain index values. Wholesale Price Index (WPI) and the Consumer Price Index (CPI) are the two major parameters used to understand and calculate Inflation.
- Wholesale Price Index (WPI): It is an indicator showing the variation of prices at the wholesale level. This is not a good indication of prices at the consumer level.
- Consumer Price Index (CPI): The consumer Price Index (CPI) is usually a better indicator than WPI as it shows the impact of change in prices at the level of the end-user, i.e., the consumer. It is the weighted average of the prices of a select few consumer goods and services. A higher CPI could mean inflation and a lower CPI, deflation. The current CPI for India is 151.6 whereas it was 144.2 at around the same time a year ago.
Impact of Industrial Production
Variations in the production levels and rates in various industries can be a determinant for the increase or decrease in stock market prices. It is measured using the Index of Industrial Production (IIP). IIP is an index calculated by taking the cumulative value related to the production of 15 select industries. When the indication is of a better production rate, it shows that the economy is having a good phase and vice versa. How does the economy affect the stock market when the index is low? Let’s see. A reduced rate of production naturally causes a high demand which will shoot the prices up. This will be directly reflected in the stock prices. When the index becomes lower, it can also change other indicators such as the repo rate, as there will be compulsion on the central bank to reduce repo rates to tackle the crisis.
National Financial reforms and Budget declarations
From time to time, the government makes reforms that can have an impact on a country’s economy such as foreign trade policies and taxes. A budget is something that plans for the overall financial and economic profile of the country for the subsequent financial year. An example of such major events that affected the stock market is the introduction of GST which changed the sales tax scenario of India completely. As a result, many industries benefited as the revised taxes were lower than earlier. For instance, the stock price of Tata Steel went up by 0.53% to Rs. 489.40 just after a day of GST declarations. This happened as the GST for coal, metal, and steel came down to 5%. They could offer their products at cheaper prices resulting in better sales.
Corporate Earnings Declaration
This is yet another answer to the question “What drives the stock market up and down?” and a major event most investors look forward to. It is the declaration by corporates at the end of every quarter of the year. The announcement will present the financial changes that occurred during the quarter. The major information disclosed in the declaration is:
- The revenue of the company during the quarter.
- The expense of the company during the quarter.
- Taxes and interests paid during the quarter.
- Profitability during the quarter.
Such information is highly valuable and it shows the financial status of a company. Investors compare the information with that of the same quarter during the previous year or with that of the previous quarter. If the information reveals that the company’s financial health is on a trail of improvement, it attracts investors and the stock prices immediately go up.
How do world events affect the stock market?
Now let’s see how certain events going on around the world can have an impact on the stock market and share prices. A fresh example before us is the coronavirus and Covid-19, the pandemic it has ignited. Everyone knows that the Covid-19 pandemic has not only affected the stock market but also human life in general. McDonald’s witnessed a global fall in sales by 23.9%. However, on the flip side, many industries have also gained from the pandemic. The one big lesson to learn from this world event is that there are at least two sides to anything. Which industries could report higher sales during a pandemic such as Covid-19? Obviously, it will be the ones that are more in demand. More people have switched to WFH (Work from Home) and hence more online life is abuzz these days. Hence, online technologies will have a higher market demand. As most of the world faces situations of lockdown, more and more people are resorting to video-conferencing to get things done and to socialize. This has triggered a hike in the share price of Zoom Video. It has ever been growing since the start of the coronavirus pandemic. It was less than US$ 70 in December 2019. And with the beginning of January 2020, it started rising. That’s when the coronavirus was first reported. And, as of August 3, 2020, its price is US$ 256.83.
Many other types of products and services in demand during the pandemic also see growth. Some of them are home game apparatuses, medical and surgical products such as sanitisers, gloves, and masks, and many online businesses. In India, investors think that the changes in the economy brought about by the coronavirus are temporary. There is optimism as thinkers look back at history. The country has faced many ups and downs. Nevertheless, Sensex has always proved that fluctuations are temporary and growth is permanent. It shows that the CAGR has changed from 100 points in 1979 to 40,000 points in 2019. Optimistic investors and observers think along these lines and wait with fingers crossed for this stage too to come to pass for a brighter economy.
How news affects stock prices
The above example was that of a social event having an economic impact. There can be economic or political events also that can have a hard impact on stock prices. Suppose a multinational company reports a growing graph for the last three quarters. Naturally, its stock prices will go up because investors see a prospect in the consistent growth of the company. They expect the growth of the company to continue the same way. It could be mere speculation at the same time, because, in the next quarter, the graph may come down as well due to some unexpected turn of events. Sometimes a mere piece of news is enough for stock prices to go up. Suppose a company declares the acquisition of a reputed brand. As soon as the news reaches the people, the stock price of the company goes up, because an acquisition is a good sign. It shows that the company is financially healthy and there is more growth to expect in the future. Sometimes the news could be a mere rumor. Still, the prices can go up, at least until people learn that it was fake. It means that mere news, and not actually an event, can also impact stock prices. No one can predict what things affect the stock market at any time.
How do wars affect the stock market?
Wars and battles are part and parcel of human life. Wars, small and big, keep happening all the time between different countries around the world. Also, civil wars or riots can break out between different groups inside the same country. From a business point of view, these are political events that can have an impact on the economy, and in turn, the stock market. So, what are the impacts that war or riot can bring about in the economic scenario of a country or region? Do stocks go down during war? Or, does war boost the economy? Let’s find out.
The case is similar to the social event of Covid-19. You can expect a mixed impact on the economic condition during the time of war. History shows that when a war breaks out all of a sudden, the stock prices go down immediately. However, if the war starts after a brief period of negotiation, waiting, anticipation, etc. where everyone knows well in advance that war is indeed going to break out, the stock prices see a rise. This is known as ‘The War Puzzle’. However, no one can be sure about the micro-details why such a phenomenon happens.
Will riots affect stocks?
By now we have seen that the answer to the question “What causes changes in the markets?” is not that simple to answer. In many cases, we may be surprised to find a kind of impact opposite to what anyone would guess. Let’s look at how socio-political events like riots and civil unrest affect the economy and the stock market. Recently, in Minneapolis, there was a civil uprising that brought the country’s economy to a standstill. It was following the alleged killing of George Floyd, a black American citizen. The economy was in a crisis. Many opined it was the largest civil strike America has witnessed ever since 1968. However, contrary to anyone’s expectations, the stock prices saw a rise. This is one of the examples of the economy and the stock market behaving in such a way as if they don’t have any relation to each other. The economy going down and the stock coming up. It could be surprising. However, keen investors know that this has been quite the norm. There have been many such examples in history. An analysis of the phenomenon may not be easy. Intelligent investors seem to know that such riots are a passing phase. The economy would rise again when the wave subsides. The investors invest during the phase of unrest thinking to reap big when the economy picks up.
“How do events affect the stock market?” has always been an interesting as well as puzzling question to investors. When one delves deep into the subject, one understands that there is no single rule to explain things. Events could be economic, social, political, or any other. Any kind of event can affect the economy as well as the stock market. Political events and issues may affect the economy in a different way than economic events. It may again be different from the impact of social events. Every social event may not have the same predictable form of effect. The same goes for economic, political, or other types of events. Sometimes you also see that the stock prices behave strangely enough to show that it has nothing to do with the changes in the economy. In truth it does. Only, the signs are subtle enough. Economic thinkers always point their finger at history. It has all the lessons you want. Perhaps it is the best place to look for answers when you are puzzled by the fluctuations in the economy and wonder what impact it could have on your investments in the stock market.