Factors That Influence the Market
News reports come up with all sorts of reasons for why stock markets fall or rise, among them news of rising inflation, of election results, or corporate earnings, to name a few.
But the fact of the matter is that millions of events influence stock prices as a whole and individual stock prices. Among the most important factors are:
- Expectations of future corporate earnings. Basically a company's current stock price reflects investors expectations of its future stream of earnings. Professional investors continually make estimates--some call them guesses--about a company's future earnings. If the company posts a result in a future quarter that is below or above that expectation, its stock is likely to fall or rise, respectively. If a lot of companies report earnings that are above expectations on the same day, stock prices as a whole tend to climb.
- Interest rates. Interest rates are rates the bank pays you on interest, the rates at which companies borrow money, etc. If interest rates rise, companies generally pay more in interest expense, which hurts their future earnings. So if interest rates rise, stock prices may fall, again anticipating weaker future profits. Interest rates also are important because investors can choose to hold their assets in stocks, bonds, cash and other assets. Because stocks are generally riskier than bonds, investors demand a higher rate of return. But sometimes they lose faith that they will get a higher return and put their money into bonds. Investors say to themselves "I can get 6 percent a year on bonds and my stocks will probably only give me 7 percent instead of the 8 percent I expected, so I'll sell my stocks and buy bonds and accept the lower return for the greater certainty that I will get my 6 percent."
- Inflation. Investors fear inflation, which reduces purchasing power. For example. If you bought a quart of milk, for, say, $1 this year, you will likely have to pay $1.03 next year to buy a quart. The greater the risk of rising inflation is, the more investors will sell their bonds, which pay a fixed rate of interest, and will put it into stocks and other assets that generally outpace inflation. By putting more money into stocks, demand rises, generally sending prices higher.
- Economic growth. When the economy is humming along, people and companies are generally buying goods and services made by companies. When sales like this rise, companies usually earn more income, thereby making their shares attractive. As a result, people buy them and share prices rise. When the economy goes into a recession, share prices generally fall--actually, they often fall before the economy goes into a recession--because sales by companies in which they own shares fall, and therefore, so do corporate profits.
- Political environment. Because government is so powerful in terms of guiding the direction of the economy, buying goods and services of companies, changing tax rates, etc. stock market prices often anticipate and react to changes in Presidential and Congressional leadership.
The above factors affect stocks generally. On an individual level, stocks are affected by many factors such as:
- Corporate earnings
- Changes in management
- News about competitors and whether they are taking business away from the company
- New products and services
and many, many other factors.
Bottom line: try to avoid changing your investment behavior based on general factors affecting stocks as a whole and concentrate on the specific companies you own in your portfolio. Follow fundamental news about whether they are coming out with new products and services, innovating, keeping costs down, winning against competitors, finding talented employees, etc.