Factors Affeccting Stock Market

8/8/2019 Factors Affeccting Stock Market

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THE BEHAVIOR OF THE STOCK MARKET

From experience we know that investors may 'temporarily' move financial prices away

from their long term aggregate price 'trends'. (Positive or up trends are referred to

as bull markets; negative or down trends are referred to as bear markets.) Over-reactions may occurso that excessive optimism (euphoria) may drive prices unduly

high or excessive pessimism may drive prices unduly low.

According to one interpretation of the efficient-market hypothesis (EMH), only changes

in fundamental factors, such as the outlook for margins, profits or dividends, ought to

affect share prices beyond the short term, where random 'noise' in the system may

prevail. (But this largely theoretic academic viewpointknown as 'hard' EMHalso

predicts that little or no trading should take place, contrary to fact, since prices are

already at or near equilibrium, having priced in all public knowledge.) The

'hard' efficient-market hypothesis is sorely tested by such events as the stock market

crash in 1987, when the Dow Jones index plummeted 22.6 percentthe largest-ever

one-day fall in the United States.

This event demonstrated that share prices can fall dramatically even though, to this day,

it is impossible to fix a generally agreed upon definite cause: a thorough search failed to

detectany'reasonable' development that might have accounted for the crash. It seems

also to be the case more generally that many price movements (beyond that which are

predicted to occur 'randomly') are notoccasioned by new information; a study of the

fifty largest one-day share price movements in the United States in the post-war period

seems to confirm this.

However, a 'soft' EMH has emerged which does not require that prices remain at or near

equilibrium, but only that market participants not be able to systematicallyprofit from

any momentary market 'inefficiencies'. Moreover, while EMH predicts that all pricemovement (in the absence of change in fundamental information) is random (i.e., non-

trending), many studies have shown a marked tendency for the stock market to trend

over time periods of weeks or longer. Various explanations for such large and

apparently non-random price movements have been publicized. For instance, some

research has shown that changes in estimated risk, and the use of certain strategies,

such as stop-loss limits and Value at Risk limits, theoretically couldcause financial

markets to overreact. But the best explanation seems to be that the distribution of stock

market prices is non-Gaussian (in which case EMH, in any of its current forms, would not

be strictly applicable).

Other research has shown that psychological factors may result in exaggeratedstock

price movements (contrary to EMH which assumes such behaviours 'cancel out').

Psychological research has demonstrated that people are predisposed to 'seeing'

patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like

seeing familiar shapes in clouds or ink blots.) In the present context this means that a

succession of good news items about a company may lead investors to overreact

positively (unjustifiably driving the price up). A period of good returns also boosts the

investor's self-confidence, reducing his (psychological) risk threshold.


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Another phenomenonalso from psychologythat works against

an objective assessment is group thinking. As social animals, it is not easy to stick to an

opinion that differs markedly from that of a majority of the group. An example with

which one may be familiar is thereluctance to enter a restaurant that is empty; people

generally prefer to have their opinion validated by those of others in the group.

In one paper the authors draw an analogy with gambling. In normal times the marketbehaves like a game of roulette; the probabilities are known and largely independent of

the investment decisions of the different players. In times of market stress, however, the

game becomes more like poker (herding behavior takes over). The players now must

give heavy weight to the psychology of other investors and how they are likely to react

psychologically.

The stock market, as with any other business, is quite unforgiving to amateurs.

Inexperienced investors rarely get the assistance and support they need. In the period

running up to the 1987 crash, less than 1 percent of the analyst's recommendations had

been to sell (and even during the 2000 - 2002 bear market, the average did not rise

above 5%). In the run up to 2000, the media amplified the general euphoria, with

reports of rapidly rising share prices and the notion that large sums of money could bequickly earned in the so-called new economy stock market.

IRRATIONAL BEHAVIOR OF THE MARKET

Sometimes the market seems to react irrationally to economic or financial news, even if

that news is likely to have no real effect on the fundamental value of securities itself. But

this may be more apparent than real, since often such news has been anticipated, and a

counter reaction may occur if the news is better (or worse) than expected. Therefore,

the stock market may be swayed in either direction by press releases,

rumours, euphoria and mass panic; but generally only briefly, as more experienced

investors (especially the hedge funds) quickly rally to take advantage of even the

slightest, momentary hysteria.

Over the short-term, stocks and other securities can be battered or buoyed by any

number of fast market-changing events, making the stock market behavior difficult to

predict. Emotions can drive prices up and down, people are generally not as rational as

they think, and the reasons for buying and selling are generally obscure. Behaviorists

argue that investors often behave 'irrationally' when making investment decisions

thereby incorrectly pricing securities, which causes market inefficiencies, which, in turn,

are opportunities to make money. However, the whole notion of EMH is that these non-

rational reactions to information cancel out, leaving the prices of stocks rationally

determined.


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INTRODUCTION

The price of listed shares fluctuates every now and then. The price for shares goes

up and down owing to a number of factors happening from individual business

units through to a complex environment of the entire economic system.

No economic activity operates in a vacuum. In our boundless, inter-connected world, the

smallest tremor can detonate an earthquake, the spark can ignite a wild fire, lack or too

much of rain, increase or decrease of interest rates. Markets react promptly and

uncharacteristically to rumours of war, change in regulatory environment (business),

political climate seen as negative by the business (investing) community, and vagaries of

ElNino, interest rate variation to general performance of the economy. The share prices

are affected either positively or negatively by a number of factors occurring within and

without the economic system.

The influence from within the country is generally categorised as domestic factors.

Those that are impacting on the business and investment from outside the country aredefined as global factors. Interest rates play a major role in determining stock market

trends. Company profits are very much an issue in share investment. Companies doing

well in their business activities are likely to attract more investors, thereby resulting in

high demand of their shares. A political development inside or outside the country -

may have bearing on share price. The political factor is visible through regulatory

processes and its influence (not specific) in share price becomes the eventuality.

Perception factors have their own fair share of contribution to share price fluctuation.

Whichever way the wind blows, prices can rise quickly as they fall, confounding the best

plans of some industries while rescuing others from the brink of disaster. These random

forces the Great Unknowns combine with the everyday laws of supply and demand,and the cyclical nature of business itself, to shape the peaks and valleys of a dynamically

shifting market. An investor may not be able to predict these forces, but analysing and

understanding them, one will be better equipped to weather the lows as you wait for the

tide of fortune to turn. It has to borne in mind that the above are, by no means, only the

factors that can influence share price movement on the exchange.

FACTORS AFFECTING SHARE PRICES

The price of the securities that are traded on a stock exchange is influenced by very

many factors. It is interesting to note that the movement in share prices is considered to

be a broad indicator of the state of a company. It is highly characteristic of that acombination of many factors causes changes in price levels of securities. Following are

the factors influencing the prices of a security in a stock market.

DEMAND AND SUPPLY

A natural force that affects the price level of a security is the interplay of its demand and

supply. Under the conditions of a perfect market the forces of demand and supply

interact, so as to determine the prices of security. Accordingly, where the supply is


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greater and with slimming demand, the prices of the security go down and vice versa.

The demand and supply of the industrial securities depends on a variety of factors such

as the yield and the general expectation about the yield, etc.

BANK/INTEREST RATES

The price of the security is greatly affected by the easiness of the funds availability in the

money market, by banks and the financial institutions to investors and brokers to

undertake the activities of buying and selling of securities. Interest rates play a major

role in determining stock market trends as they affect the funds availability and cost.

Bull markets (those in an upward market) are usually associated with low interest rates,

and bear markets (those in a downward trend) with high interest rates. Interest rates

are determined by the demand for capital pushes them up and normally indicates that

the economy is thriving and that shares probably expensive. Low interest indicate low

demand for capital, thus liquidity builds up on the economy, driving share price down.

MARKET PLAYERS

The activities of players in a stock exchange such as underwriters, share brokers, banksand financial institutions are responsible for causing fluctuations in share prices,

especially of the new companies. The market intermediaries through the large scale

buying of securities may attempt to create an artificial scarcity for the securities of some

companies, and thereby jack up the share prices. Similarly, the actions of institutional

investors also stimulate the demand of securities.

DIVIDEND POLICY

The extent of price level prevailing for a particular security is greatly determined by the

ability of a company to pay dividends to its shareholders. The dividend paying ability is

dependent upon the financial capacities of the company. Accordingly, a company that

has profitable investment opportunities with excellent cash flows will be in a betterposition to pay the dividends periodically. This in turn, determines higher or lower

prices. It is interesting to note that the dividends act as signalling devices for share price

movements.

PROFILE OF MANAGEMENT

The profile of top management has got a lot to do with a way the policies of the company

are formulated and implemented. Similarly, any change that is brought about in the

board of management of the company will affect the quality, soundness and the financial

stability of the company. Such changes may lead to positive or negative reactions in the

investor community. This in turn will cause the price determination to take place in a

certain fashion. For instance, the sudden demise of a popular director may cause plungein the share prices.

TRADE CYCLES

The ups and downs in the economy called trade cycles are also responsible for causing

price movements in a particular fashion. Accordingly, in times of prosperity where there

is high order of consumer and industrial activism, the market looks up. This shores up

heightened activity on the stock exchange leading to higher market prices. The investors


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will take part in stock market activities in a large number and with loads of enthusiasm.

The converse happens in times of depression with share prices plummeting.

SPECULATION

The activities of speculators such as the bulls and the bears cause upward and

downward movements in the prices. They cause fluctuations in the share prices. For

instance, the action of bull speculators who start buying in the expectation of a profit

from the upward movement of the prices causes the prices to move upward naturally, in

the same manner, the actions of bear speculators will lead to selling pressure, with share

prices coming down. On the other hand, when bulls liquidate their holding, they lower

the prices on the stock exchange. Similarly large scale buying by bears to meet their

short sales will force the security prices upwards. Thus, speculative pressures engineer

price volatility.

POLITICAL FACTORS

The changes and the policies of the political leaders at the helm of affairs of a country

vastly determine the price of a security. The stock exchange will act as a barometer thatreflects the changes taking place in the political arena. Accordingly positive changes will

cause a spur in the share prices and the political disturbances will cause price to tumble.

In fact, political considerations play much greater role in price movements than any

other factors. This is because politics is chiefly responsible for policy formulation and

implementation in the economy, governing the industrial development.

FOREIGN INSTITUTIONAL INVESTORS (FII)

Foreign capital flows have come to be acknowledged as one of the important sourcesof

funds for economies that would like to grow at a rate higher than what theirdomestic

savers can support. The Investment by FIIs has been registering a steadygrowth since

the opening of the Indian capital markets in September 1992. That thistrend has come tostay is evident from the fact that the FIIs investment in equity anddebt markets

amounted to Rs.130 billion in the first quarter of calendar 2004, nearly447% higher

than Rs.24 billion in the corresponding period of calendar 2003. Equityinvestments by

FIIs amounted to Rs.112 billion between January and March 2004 ascompared with

Rs.17 billion in the corresponding period last year. The equityinvestment by FIIs in the

first quarter of calendar 2004 are close to 50% of the total equity investments worth

Rs.244 billion made in the year 2003. In 1991 India was again hit by a very serious

political and economic crisis compared to that of 1966. Foreign exchange reserves

decreased to a level which is sufficient for only two weeks of imports and India faced a

debt crisis. Then India introduced a New Economic policy guided by the IMF and the

World Bank. The main features of the New Economic policy consisted of stabilizationwith deregulation, liberalization, privatization and globalization.

Though the FIIs flows to India have been almost positive, they have also been negative

during the periods of external shock or a domestic political uncertainty. For example,

the literature survey elaborates that the FIIs flows turned negative in September 2001

following the 9/11 terrorist attacks. Another example was nuclear tests in May 1998.

With the help of FIIs Investment the foreign Exchanges reserves increased rapidly.


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Oil price is one of the main factors affecting Indian economy as well as Indian stock

markets. The price of oil going forward, we cannot control the rupee depreciation. We

can observe the last few years some kind of stable equilibrium between the rupee and

the dollar has been achieved and, while there clearly will be some volatility, dramatic

changes in the exchange reserves are unlikely. The probability of an exchange rate shock

exacerbating the impact of high oil prices is relatively low and India is not exposed to

price risks to a greater extent than the world economy.

FOREIGN EXCHANGE RESERVE (FER)

Indias capital account liberalization measures have been largely effective. Amongother

factors, suitable policy measures in respect of the external sector insulated Indiafrom

the 1997 Asian crisis. We have moved forward gradually towards CapitalAccount

Convertibility with a broad reform agenda that encompasses trade,competition, reform

of the financial system and industrial restructuring.

As evident from various economic indicators, the liberalization process that hasbeen

underway for some time has created a more competitive environment for

Indianindustry than that existed earlier. Consequently, the Indian companies have

upgradedtheir technology and expanded to more efficient scales of production and

refocusedtheir activities to areas of competence. Increasingly, Indian companies are

looking tobecome global players. Reform measures in the external sector, including

dismantlingof exchange control have been a contributor to this development. We would

continueto participate actively in the process of economic and financial globalization,

toaccelerate domestic economic reforms and to continue with our firm commitment

toliberalization so as to serve the needs of economic growth and development of

thecountry. An increasingly liberalizing foreign exchange regulatory regime will be

anessential ingredient of this vision.

As per newspaper reports (The Hindu, 2004) the reserves had crossed US $ 100billion

mark and continued to head upwards. By the end of f iscal year 2001-02, thereserves had

exceeded 12 months import cover. Nevertheless, it is important to note,that around 30

per cent of these deposits comprised ofNRI funds, which was attracted by both higher

Indian relative interest rates, and full capital account convertibility forNRIs in the post-

2002 changes. In addition there are annual flows of remittancesbetween US $10 billion

to US$15 billion, which might be affected by a change insentiment, which could occur as

the global interest rate regime changes and as theperception of risk of depreciation of

the Indian rupee increases. Bank inflows havealso increased mainly driven by foreign

banks. This could improve competitionthough it could also slow down improvements in

NPAs of government-owned banks.Such sharp increases have made the task of

managing the inflows difficult; both interms of their sterilization and in terms of

ensuring a competitive exchange rate. Thereis also the risk of large outflows due to theincreased perception of a depreciation ofthe rupee as a result of change in global

interest rate. Improvements in reserves haveenabled the RBI of relax to controls on

resident Indians.

COP (CRUDE OIL PRICES)


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The global markets for crude oil are fairly well developed and are characterized by

thepresence of spot, forward, and derivatives markets. The market price responds

todemand and supply perturbations arising from various influences, including

anychange in OPEC (Organization of Petroleum Exporting Countries) policy, or

theweather pattern of any major crude consuming country. As the Middle East region

hasglobal predominance in reserves and production of crude oil, any

destabilizingpolitical developments in the region have a major impact on the price.The

market also responds to threat perceptions Oil and gas industry is the mostimportant

sector in any economy since it caters to a wide range of industries

includingpetrochemicals, fertilizers, automobiles etc., Thanks to its importance and

limitedavailability; it is one of the highly regulated sectors in India. Government policies

in India have changed considerably in the post-liberalizationera, with private and

foreign players getting the nod to indulge in oil exploration andproduction through

schemes like New Exploration and Licensing Policy (Nelp) I, IIand III. Hence, there is a

good scope for domestic private players and foreign playersto enter into this sector.

SI (SAVING INVESTMENTS)

SI indicates gross domestic savings and is directlyproportional to investments in stock

markets.One of the prerequisites of putting India on a high growth path is a substantial

risein domestic savings. This will require tighter fiscal policies and strong

structuralreforms, including liberalization of financial markets.India's saving rate is

relatively high, compared to that of other countries.Historically, domestic savings has

been dominated by household saving in physicalassets. However, the recent increase in

saving has been driven mainly by financialhousehold savings, partly reflecting a

continuing expansion of financial institutions'branch networks into rural areas and,

more recently, the increasing availability ofalternative investment opportunities. Private

corporate saving has also shown a steadyincrease over the last twenty years, although it

remains below 5 percent of GDP.

Public saving weakened in the early 1990s to reach a low of 0.5 percent of GDP

in1993/94, which a significant reduction is compared with the levels of 45 percent

ofGDP seen in the early 1980s.

OTHER FACTORS

In addition to the above mentioned factors, the following factors are also responsible for

causing price variations:

y The personal health of the head of governmenty Weather conditionsy Industrial relationsy Competitive market conditionsy Corporate activism such as mergers and amalgamationsy Conditions of balance of paymenty The general price levelsy General market sentiments

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Factors Affeccting Stock Market