Second, it is a function of inflation or interest rates , arguably. Higher inflation earns a higher discount rate, which earns a lower multiple meaning the future earnings are going to be worth less in inflationary environments. In summary, the key fundamental factors are as follows:. Things would be easier if only fundamental factors set stock prices.
Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Some of these indirectly affect fundamentals. For example, economic growth indirectly contributes to earnings growth.
Technical factors include the following. We mentioned it earlier as an input into the valuation multiple, but inflation is a huge driver from a technical perspective as well. Historically, low inflation has had a strong inverse correlation with valuations low inflation drives high multiples and high inflation drives low multiples. Deflation , on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies.
Company stocks tend to track with the market and with their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements—as opposed to a company's individual performance—determines a majority of a stock's movement.
For example, a suddenly negative outlook for one retail stock often hurts other retail stocks as "guilt by association" drags down demand for the whole sector. Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds , government bonds, commodities , real estate, and foreign equities.
The relationship between demand for U. Incidental transactions are purchases or sales of a stock that are motivated by something other than belief in the intrinsic value of the stock. These transactions include executive insider transactions, which are often pre-scheduled or driven by portfolio objectives.
Another example is an institution buying or shorting a stock to hedge some other investment. Although these transactions may not represent official "votes cast" for or against the stock, they do impact supply and demand and, therefore, can move the price. Some important research has been done about the demographics of investors.
Much of it concerns these two dynamics:. The hypothesis is that the greater the proportion of middle-aged investors among the investing population, the greater the demand for equities and the higher the valuation multiples. Often a stock simply moves according to a short-term trend. On the one hand, a stock that is moving up can gather momentum , as "success breeds success" and popularity buoys the stock higher. On the other hand, a stock sometimes behaves the opposite way in a trend and does what is called reverting to the mean.
Unfortunately, because trends cut both ways and are more obvious in hindsight, knowing that stocks are "trendy" does not help us predict the future. Liquidity is an important and sometimes under-appreciated factor.
It refers to how much interest from investors a specific stock attracts. Wal-Mart's stock, for example, is highly liquid and thus highly responsive to material news ; the average small-cap company is less so. Trading volume is not only a proxy for liquidity, but it is also a function of corporate communications that is, the degree to which the company is getting attention from the investor community.
Large-cap stocks have high liquidity—they are well followed and heavily transacted. Many small-cap stocks suffer from an almost permanent "liquidity discount" because they simply are not on investors' radar screens. While it is hard to quantify the impact of news or unexpected developments inside a company, industry, or the global economy, you can't argue that it does influence investor sentiment.
The political situation, negotiations between countries or companies, product breakthroughs, mergers and acquisitions, and other unforeseen events can impact stocks and the stock market.
Since securities trading happens across the world and markets and economies are interconnected, news in one country can impact investors in another, almost instantly. News related to a specific company, such as the release of a company's earnings report, can also influence the price of a stock particularly if the company is posting after a bad quarter. In general, strong earnings generally result in the stock price moving up and vice versa.
But some companies that are not making that much money still have a rocketing stock price. This rising price reflects investor expectations that the company will be profitable in the future. However, regardless of the stock price, there are no guarantees that a company will fulfill investors' current expectations of becoming a high-earning company in the future.
Market sentiment refers to the psychology of market participants, individually and collectively. This is perhaps the most vexing category. Market sentiment is often subjective, biased, and obstinate. READ Media sentiment and international asset prices. Never miss a story! Stay connected and informed with Mint. Download our App Now!! It'll just take a moment. Looks like you have exceeded the limit to bookmark the image. Remove some to bookmark this image.
You are now subscribed to our newsletters. They then analyse the response of equity prices to sentiment shocks. Subscribe to Mint Newsletters. There are several theories that try to explain how market sentiment can drive the supply and demand of stocks:.
The Behavioral Financial Theory: This theory looks at psychological factors when analyzing financial markets. Some investors act on emotion and in some cases, overconfidence in a particular security or asset. These reactions can cause biased investing decisions, potentially hurting your investment. The Animal Spirit Theory: This theory assumes that people act on instinct in situations of uncertainty, the same way animals are said to operate.
In turn, actions — like making moves on the stock market — are also driven by instinct. When the market is good, investors will buy. When the market is bad, investors will sell. The lower the VIX, the lesser the fear. When the market is stressed, VIX goes up. The VIX averaged Keep in mind that even with careful research, investing always carries some inherent risk.
An easy way to do this is by primarily investing in ETFs and index funds instead of individual stocks. Index funds and ETFs are great ways to build wealth with relatively low maintenance and low barriers to entry. Ultimately, though the stock market may have its ups and downs in the short term, investing is a great way to build wealth in the long term.
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