11. What Influences Stock Market Movements?
Investor sentiments can affect the direction of the stock market. Investor’s optimism and confidence is often tied to an economic recovery or economic boom and can create an upward trend in stock prices. On the other hand, lack of confidence and optimism at investors’ end is reflected in a market where stock prices are tumbling. In addition to that, other factors that can affect the stock market include:
- Consider the example of an auction. If more people bid on a particular product, its price goes up. Similarly, if more investors want a particular stock, it’s demand and price will go up.
- Company-specific factors can affect stock prices. These factors include announcement of a dividend, expected earnings or profits, a change of management, changes in workforce or introducing a new product to the market. Suppose a pharmaceutical company called Pharma Z made a surprise announcement to the public that their research department has found an oral 12-month cure for cancer. This unexpected but positive surprise will motivate investors to buy the stock of Pharma Z. Increase in demand will drive up the stock price of the company.
Suppose the State Bank of Pakistan increases the interest rates in the economy. Consider the case of a manufacturing company that was planning to borrow money from a bank. Its plan will be affected because the cost of borrowing that money i.e. interest rate has increased. If the borrowed money was supposed to be used for funding daily business activities, it may lead to lower profits. Consequently, the share price of this company may drop and it may not pay any dividends. In this economic scenario, investors would prefer to invest their money in financial instruments that pay higher interest rates rather than stocks.
If investors expect economy to be strong in the future, they will assume businesses will grow and profitability will increase. This positive expectation can lead to a rise in stock prices. Economic indicators such as inflation rate, budget deficit, Gross Domestic Product or unemployment rate can point toward changes in spending or saving pattern in an economy.
- : Changes in the rest of the world can affect local economy and stock markets. Suppose a natural resource is scarce and witnesses frequent supply-side pressures. This means that the supply of this resource is limited and therefore, the price needs to increase. If the price of this resource increases in the rest of the world, it’s price in Pakistan will also have to increase in order to stay competitive. Key International events that can affect the stock market includes war, free trade policies, natural calamities, actions of foreign governments and currency fluctuations.
- A new government may introduce policies that can either hamper or strengthen businesses in an economy. The expected impact of these policies on business profitability can positively or negatively impact the stock market.
- Currency fluctuations can affect the expected profitability of businesses and stock markets in an economy.
11.1. Stock Market & Currency Fluctuations
Suppose you can buy 1 US Dollar for 100 PKR. In 2 months, it is expected that the US Dollar will increase in value and you will have to pay PKR 105 to get 1 US Dollar. Let’s say a mobile phone manufacturer imports battery from United States. Suppose a single battery costs USD 1. In order to pay USD 1 for a single battery, this firm has to convert PKR 100. However, in 2 months, this firm will have to pay PKR 105 to get the same USD 1. This reflects that the cost of selling mobile phones is expected to increase and this can impact the profitability of this firm in the future. Investor’s negative expectations based on the news regarding expected increase in value of USD can ultimately affect the stock prices.
Let’s look at another example. A firm is involved in manufacturing apparel such as jackets, trousers and jeans. This firm export and sells 90% of its products to consumers in United States. In 2 months, the US Dollar is expected to increase in value from PKR 100 to PKR 105. Suppose the price of a single jacket is USD 20. The firm will get USD 20 and convert it to PKR 2,000. However, in 2 months when the value of USD increases, the firm would be able to make PKR 2,100 by selling the product for the same price of USD 20. This is a positive surprise for the investors of this firm and therefore, its stock price may surge.
Therefore, an increase in value of US Dollar is expected to have positive impact on an exporter but negative impact on an importer.