How External Elements Can Impact Stock Prices

Just as internal factors such as management and earnings can play a part in how a stock price moves, external circumstances also play a major part. Identifying these events would be useful to investors to assist them in predicting stock price movements.

Below is a beginner’s guide of external elements which can cause changes in stock prices.

Interest Rates: Interest rates have a direct impact on companies as it affects their borrowing capacity. To grow the business, companies borrow funds from banks. When interest rates are low, it encourages them to borrow more funds and expand the business. When interest rates are high, it deters them from borrowing from the banks and they are less likely to expand the business. Growth can drive up a stock price so when investors can see an increase in earnings, they will be more willing to buy a stock than a stock with no growth. Investors tend to sell their shares when interest rates are raised and put their money into bonds to take advantage of the higher rates.

Inflation:  When inflation occurs consumers find it harder to spend money. Companies will find it difficult to generate revenue when the purchasing power of consumers are restricted. If consumers are unable to purchase, this reduces sales for companies. High inflation is not good news for the stock market as it leads to higher interest rates. Stock markets usually decline when interest rates are high.

Political Changes: Changes in government and particular policies which affect businesses have a strong impact on the stock market. We had a recent example of this last year when Donald Trump came into power and proposed numerous pro-business policies. The stock market saw these policies being favourable to businesses and we saw the S&P 500 rally.

Exchange Rates: This has an impact on the stock prices as companies which export overseas see sales increase when the Aussie dollar drops and they will see sales decrease when the Aussie dollar increases. Other countries will find it cheaper to buy from Australian companies when our exchange rate drops.

Industry performance: Stock prices within the same industry tend to move in sync with each other. Companies in the same sector will be affected in the same way if news comes out which will affect the entire industry. For example, last year stocks in the telecommunications space took a beating after the roll out of the national broadband network. This roll out was a large capital expenditure and investors were unsure of the return this capital expenditure would generate.

Economic Environment: Companies generate more growth when the economy is strong and consumers are in a stronger position to buy. In a recession, money is tight and consumers will be less likely to spend as freely as they would when the economy is strong. More consumer spending leads to more profits for companies so a weak economic environment is not good for businesses.

Unemployment/Redundancies: High unemployment rate would indicate less purchasing power from consumers which would be a negative to business if consumers are restricted in spending. If there is a large risk of redundancies to employees, consumer would also be averse to spending money due to pending potential of losing a job.

Consumer Confidence: This economic indicator measures the consumer optimism on the state of the economy. The Westpac-Melbourne Institute Consumer Sentiment Index is calculated from a survey of 1200 Australian households. There are five components of this index which convey the consumers opinion of their household financial position over the past year and the coming year.  This indicator is important as a confident reading shows consumers are more likely to spend money. A low indicator would show consumers have low consumer confidence and less willing to spend money. This would impact businesses and stock prices if consumers don’t spend money on their products, as there is less potential for earnings growth.

Market Sentiment: Stock prices also move in accordance to the general market sentiment. If there is optimism in the market there will be a lot of buyers pushing stock prices up. If investors are pessimistic then this will drove the stock market down.

Terrorism: Terrorism incites fear and panic. This fear can encourage selling as we saw many people selling their investments after 9/11. When there is insecurity in financial markets, this can initiate a lot of selling.

Lauren Hua is a private client adviser at Fairmont Equities.

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