Stock markets can be volatile, and the reasons particular stocks rise and fall can be complex. More often than not, stock prices are affected by a number of factors and events, some of which influence stock prices directly and others that do so indirectly. According to stock market guru Peter Lynch, an important point to remember when investing is that "there is a company behind every stock and a reason why companies – and their stocks – perform the way they do."
What factors affect financial markets?
The market which is constituted by corporates and all other business entities function in a certain set of environments and is in constant interaction with them. Hence, changes in the environments 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 affects the stock market.
1-Monetary Policy
2-Inflation
3-Industrial Production
4-National Finance Reforms and Union Budget
5-Corporate Earnings
6-General Elections and Stable Government
7-Unscheduled Events
1. Monetary Policy
The monetary policy of any country can affect the market prices significantly. The monetary policy concerns fundamentally with controlling the money in circulation by the central bank of any country by adjusting certain interest rates. In India, 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 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. 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.
• Reverse Repo Rate: Reverse Repo rate is also one of the macroeconomic factors affecting 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 the money remaining with the banks. Such deficiencies will also affect the economy directly.
2. Inflation
Another one among 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 for prices at the consumer level.
• Consumer Price Index (CPI): 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.
3. 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.
4. National Financial reforms and Union Budget
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.
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