Impact of macroeconomic factors on stock markets

The stock markets and world economics have been a talking point almost every day on the news channels and every media stream. The current status of the economies around the world and their stock markets are influenced by various factors that are internal or external to such economies. The relationship between macroeconomics and the stock market has to be studied at great length to understand how they influence the latter. This will help investors and traders analyze the markets and react accordingly to create a successful portfolio.

Table of Contents hide

1 What are macroeconomic factors?

2 Which macroeconomic factors impact the stock markets?

3 Conclusion

4 FAQs

5 Other interesting reads

What are macroeconomic factors?

The starting point for this discussion has to be with the basic meaning of macroeconomics. Macroeconomic factors are broad market factors that affect the economy as a whole. These factors may or may not be external to a country and are often man-made or natural but have the potential to change the course of an economy.

Some examples of such macroeconomic factors are natural disasters like earthquakes, famines, droughts, or manmade situations like war, global inflation, recession, etc. These factors impact the key parameters or pillars of an economy like its GDP growth rate, stock market trends, major industries, etc. Therefore, it is important to understand these factors and ascertain their impact on the economy as a whole.

Which macroeconomic factors impact the stock markets?

Stock markets are highly volatile and are one of the first pillars of an economy to react to any macroeconomic changes. Given below are some of the key macroeconomic factors and their impact on the stock markets.

Exchange rates

The currency rates around the world have been tumbling for a long time now. Many giants like the Japanese Yen, the Euro, and Sterling Pound have all seen a sharp decrease in their values in recent times.

The Indian Rupee is no different. Although many experts say that the INR has performed far better than the currencies of other major economies, it is a fact that the rupee is at an all-time low against the dollar. The direct impact of the exchange rate fluctuations is seen in the stock markets. Any rise in the dollar sees a sharp decline in the stock markets and vice versa. The rise in the value of the dollar implies that FIIs will get more returns for their investment in the US markets than in India and hence they pull out of the Indian markets, thereby triggering a fall in the broad market indices.

Inflation

The simple explanation of rising inflation is the rise in the cost of living or reduction in the purchasing power of money. Inflation is always viewed as a villain for an economy but the fact is that a healthy inflation level is considered to be good for the economy, especially for a developing economy. However, the stock markets have traditionally seemed to have an inverse relationship with rising inflation. An increase in inflation will see a reduction in the disposable income for investors at large which will lead to a lowering of their investments in stocks and other investment options. This leads to a general decrease in the demand for stocks and therefore a bearish mood.

Price of Crude oil

One of the steepest purchase bills for countries these days is crude oil. The rising crude oil prices have been eating into the foreign reserves of India along with that of multiple countries becoming a global concern. The rising crude oil prices trickle down to many sectors like the auto sector, auto components sector, paints, airlines, refineries, etc. The rising costs affect the bottom line of the companies and thereby their stock prices. Therefore, crude oil has a direct impact on the stock markets in the form of an inverse relationship

Fed interest rates

One of the many actions taken by governments to fight rising inflation is an increase in interest rates. Recently the US saw an all-time rise in inflation levels prompting the Federal Bank to increase their interest rates. This increase in the US yield rates had a negative impact on the stock markets as they saw a sharp decline with the FIIs pulling out of the Indian stock markets. The US treasuries are considered to be safer investment options and therefore when the Fed rates increase, the stock markets in India see a sharp decline. This indicates an inverse relationship between the Fed rates and the Indian stock markets.

GDP

The GDP of an economy is the measure of the relative performance of the economy in absolute terms as well as in percentages. It is the value of all the goods and services produced in the country and exported that is measured annually and quarterly. The stock markets react immediately to the announcement of the GDP results of the company.

A rising GDP level indicates a positive outlook for the economy, thereby boosting stock prices. Companies reporting positive financial results in a rising GDP boosts the confidence of the investors (retail and institutional investors) which further creates a bullish market. A fall or a rise in the GDP of a country has a long-lasting impact on such an economy but the stock markets react promptly and adjust to the news in a negative or positive manner respectively indicating a direct relationship between the two.

Changing political news

The factors like inflation, rising crude oil prices, and Fed rates, are external factors that impact the stock markets of a country. However, certain internal factors like the political scenario of a country also have an immediate impact on the stock markets. An unstable political scenario will have an adverse impact on the stock markets of the country. There will be a lack of confidence from institutional investors (foreign or domestic) to invest in the country due to political instability.

Furthermore, any policy decisions taken by the government (monetary policy, fiscal policy, etc.) will also have a direct impact on the stock markets. The perception of the investors is shaped based on the intended outcome of such policies which may or may not be favorable to the economy triggering volatility in the stock markets.

Conclusion

Macroeconomic factors, although may or may not be related to a particular country, will impact its stock markets nevertheless due to the extreme globalization of economies. Hence, it is naive to overlook any global developments and to think it does not impact us. Seasoned and experienced traders and investors, therefore, know that while making projections of the stock markets and any investment decisions, it is important to consider the macroeconomic factors and their impact on the said investments.

FAQs

What are the other major macroeconomic factors that can affect the stock markets?

Some other macroeconomic factors that can have a direct or indirect impact on stock markets include gold prices, US stock markets, unemployment figures of a country, company results, etc.

Should retail investors understand macroeconomic factors while making investment decisions?

Yes. Retail investors cannot be left aloof from the impact of macroeconomic factors on the stock markets. Hence, while creating or rebalancing their investment portfolio they have to consider the impact of global or national macroeconomic factors on stock markets and thereby their personal investments.

What is the impact of rising gold prices on stock markets?

The increase in gold prices usually has a negative impact on the stock markets indicating an inverse relationship between the two.

Should investors have a short-term or long-term investment approach in considering the impact of macroeconomic factors on stock markets?

The volatility of stock markets due to changes in macroeconomic factors gives a good opportunity to make short-term gains. However, risk-averse investors should always invest with a long-term investment approach as in the long term, equity markets have been known to provide better returns.