Fundamental analysis of companies can give us insights into their financial health. Technical analysis can provide an insight into how a stock is trending. However, investors cannot ignore macro factors within the current economic environment. Some of these factors include economic growth, unemployment, inflation, interest rates, and exchange rates. All of these can affect the stock market. If investors are aware of these factors, they can adjust their portfolio to lessen portfolio losses or maximize profits.
The economy’s overall health has an impact on the stock market. When the economy looks like it is growing then companies have the potential to expand and increase profits which can increase share prices. Consumer spending increases when the economy is strong as individuals feel more confident about their financial position. When the economy is slowing then companies will find it harder to expand and increase earnings. If consumers are also not very confident of the future they will choose to save instead of spending money on non-essential item.
If investors see the economic outlook looking poor, they may think about selling down equity positions or be more selective about positions which they take on. A strong economy also gives investors confidence in the equity market. When the economy is weak, investors look to protect their capital and move funds into safe haven such as bonds which do not generate returns as high but also do not produce losses as low as the equity market.
Wages are the biggest indicator of consumer spending. When unemployment is high then consumer spending drops. Funds may be limited so consumers will spend less on discretionary items and allocate spending only to essential items. This may restrict the earning capacity of companies which then affects stock prices. Consumer staples and defensive sectors are usually the better performing stocks in a high unemployment environment. For more information of what stocks to buy in a market downturn see the article Strategies for a stock market downturn.
Inflation affects the stock market as it impacts the level of consumer spending. When the cost of goods and services continue to rise then this means consumers have less money to spend on non-essential items. Rising costs impact businesses and their profits as input prices are higher. They may pass this on to consumers or if they need to stay competitive then they need to absorb these costs which lowers corporate profits. Lower revenues and profits can then contribute to the falling share prices of the stock. Oil stocks, consumer staples, gold stocks, healthcare and material stocks benefit from inflation. We have written up an article previously on 6 sectors which benefit from high inflation.
High interest rates negatively influence the stock market. Stocks usually sell off when there is any talk of a rate hike in the future. High interest rates restrict borrow borrowing capacity for business so this impedes their ability to grow the business. This stagnation in business growth can affect earnings growth and then stock prices. Rising interest rates also affects consumers as they may experience an increase in mortgage interest payments which can then restrict their purchasing power. This could create less demand for non-essential goods and services which then affect company earnings and stock prices. We have written up previously an article on The effect of interest rates on the stock market.
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A weak exchange rate means exports are cheaper internationally. This is good news for companies who export products and services overseas as demand increases and earnings rise. A high exchange rate may mean cheaper imports, so this is good news for companies who use imported goods such as electronic retailers or manufacturing companies. However, a strong exchange rate may also cause some companies to struggle as the price of the goods and services become uncompetitive compared to other countries. For more depth on this subject, we have written an article called “The positive and negative effects of a strong aussie dollar”.
Lauren Hua is a private client adviser at Fairmont Equities.
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