Factors affecting the stock market
If you have been a stock investor for several years, you should have known by now that a stock’s demand and supply dynamics are not the only thing that moves the stock market. There are many other factors including news that affects the stock markets. The news can be any kind of news such as stock specific news, macro-economic news or global market news.
Markets don’t react to only news that has already broken, they react to anticipated news too. In fact, markets react more rapidly to rumours and theories. Our stock markets have the tendency to discount events much before they happen. So, here’s a look at all the factors that will affect the stock market.
Institutional investor inflows
This is one of the most important factors that have a major influence on the market sentiments. Institutional investors include Foreign Institutional Investors (FII) and Domestic Institutional Investors (DII). FIIs invest into the Indian markets for many reasons including the fact that interest rates here are higher than in developed markets and emerging equity markets have the potential of providing higher returns than those in developed nations. DIIs include mutual funds that buy shares and bonds.
FIIs and DIIs with their huge amount of investible surplus have the ability to turn around market sentiments when they deploy money in the equity market. Take for instance, the month of January 2020. FIIs were net sellers during the month and according to the Securities Exchange Board of India (SEBI) data, their net outflows from the equity markets during the month totalled Rs 5,359 crores. The Sensex lost over 3.3% during the month.
Interest rate changes
The interest rates in the country affect a number of major economic factors including bank deposit rates, loan rates, demand for goods and services, consumption, industrial growth, among others. Interest rates have an impact on the stock market too. Any major change in interest rates affects the ‘rate sensitive’ sectors of the stock market more than the others. These include banks (which provide loans), automobile companies (which depend on consumers who avail auto loans) and real estate (which depend on people who avail housing loans).
There are several Indian as well as international economic data that are released every week, month or quarter that has an impact on the stock markets. These include Index of Industrial production (IIP), Gross Domestic Product (GDP) estimates, manufacturing data, consumer sentiment, among others. Markets react within minutes to news on these numbers being released. Not only national, international economic data also has an impact on Indian markets.
Depreciation or appreciation of the Indian rupee against the US dollar, British pound and other currencies always has an impact on the equity market. Rupee movements also have an impact on certain sectors that import or export goods or deal with foreign clients.
India is largely dependent on the monsoon every year for staples such as rice and wheat. So, any news on the monsoon has a great impact on the market. A favourable monsoon tends to have a positive impact on the markets.
Union Budget, RBI policy reforms, national or state elections – you name any political, economic or national/international event; they have an impact on the stock market. For instance, a surge in coronavirus cases outside China triggered a selloff in global equity markets on 24th Feb, 2020. Indian markets were affected too. Indian stock market benchmark Sensex tanked by over 800 points to 40,363.23, wiping out over Rs. 3 lakh crore of investors’ wealth.
Investor confidence and expectations
A key factor that sways the market is the mood of the investors. If they receive positive news that gives optimism then they are more likely to buy shares. If they receive bad news they will sell. For instance, if investors feel the worst for the economic recession is over, the stock market can rally even when economic fundamentals remain poor.
Inflation is a huge driver of the stock market. Historically, low inflation has had a strong inverse correlation with stock valuations. Deflation, on the other hand, is generally bad for stocks because it is considered a loss in pricing power for companies.
Any purchases or sales of a stock motivated by something other than its intrinsic value can move the stock market. Transactions such as executive insider trades can have an impact on the equity markets.
Market liquidity is an important factor. It refers to how much interest investors have in a stock. Liquidity is about the trade-off between the speed of the sale and the price it can be sold for. In a liquid market, you can sell quickly without the sale reducing the price much. In a relatively illiquid market, selling quickly will result in fall of price by some amount.
Large-cap stocks have high liquidity as they are well followed and heavily transacted. Many small-cap stocks have liquidity issues because they simply are not on many of the investors’ radar screens.
Apart from all these factors, it would be prudent for you to note that you should not take any decisions based on any of the news unless it is company specific. Always look at individual companies and their long-term earning potential. When you hear company specific news, confirm the same from the company to verify if the news is true or false.
If you are not sure about how to invest in stocks, invest in mutual funds. They invest in stocks on your behalf and have known to give better returns than traditional investments in the long-run.