Factors That Affect Emerging Stock Markets - Literature review Example

 Factors That Affect Emerging Stock Markets Introduction The annual total output of goods and services is a measure of country’s economic well being. The production of goods and services is very important because it determines the growth of an existing economy. Such growth is very important because it determines the capacity of the nation to promote further its economic status in the world. A growing economy requires many things and one of them is oil. Oil is such an important material in order to produce goods and services. It may not be directly involved in the production of goods and services but it substantially helps move the economy. This is the reason why many studies are conducted to measure the extent up to which oil influences the growth of stock market in emerging economies. Oil is the world’s largest basic commodity and it is due to this fact that it is important to consider finding some important relationship it has with the existing modern economy. Oil according to Basher and Sadorsky (2006) is the lifeblood of modern economy. Oil supports the world’s economy because it is one of the main materials needed in the production of goods and services. It may not have direct involvement in the creation of goods and services but without oil, many of on-going business transactions today will suffer. In the case of transportation, there is going to be difficulty in reaching goods from one place to another or from one country to another without oil. Oil is remarkably a very important resource of the humanity and there is no wonder why many studies directly associated with it are mushrooming at present time. From political, social down to economical, there are various studies regarding oil. From economic point of view, it is important to understand that oil may have direct or indirect impact on the growth of the market. Thus, it is important to take a look at this by understanding the impact of oil on the growth of stock in emerging markets. Since oil may not have direct impact on stock market, it is important to understand that there must be some factors that lead to major changes of the following 11 emerging markets: Brazil, Saudi Arabia, Jordan, South Africa, Poland, Malaysia, Peru, Argentina, Turkey, Pakistan and Venezuela. From a geographical point of view, emerging markets refer to those markets emerging in the horizon of Asia, Middle East, Latin America, Central Europe and Africa (Huang, 2007). These are areas where emerging markets are located with inclusion of political, social, economical, financial and cultural considerations. The following are some of emerging markets with their brief background or history leading to their eventual changes from 1999 to 2009. Brazil Brazil is considered by Europeans as an emerging market and as such there is considerable potential for market growth. Europeans are looking for emerging markets and among of them are in Asia and Brazil (Nicholson, 2010). It is not only enough that the market is emerging but other consideration taken into account by investors is the market size. Brazil is one of the largest markets and the opportunity can be promising for investors (de la Torre and Schmukler, 2007). Financially speaking, investors are looking for liquidity of the state as far as their will to invest is concerned. In the case of Brazil as an emerging and substantially large market, the repo transaction which has become the basis of liquidity tries to exceed the value traded of the underlying assets (de la Torre and Schmukler, 2007). The potential for diversifying risk by investing in Latin America including Brazil in particular is limited (Chen et al., 2002). This implies that Brazil as an emerging market got a great deal of opportunity for investors. With this, the status of its stock market can be considered growing and entices many investors at the same time. Another consideration involves country, regional and global market risks that can contribute to the daily changes in yield spread. In Brazil, the yield spread is driven by global risk and it is also contributed by country risk and this varies with bond maturity (Audzeyeva and Hoppe, 2010). The cost of capital is another consideration in investment among investors and corporate managers. It was found out that Brazil together with four other Latin American countries like Argentina, Chile, Colombia and Mexico have significant correlation on their stock market prices from 1992 to 1997 which implies first and second moment time dependencies which further good indicator of cost of capital enticing to investors and corporate managers (Christofi and Pericli, 1999). International portfolio diversification is a trend which creates small long-run benefits and one of them is the momentary adjustment of stock prices (Diamandis, 2009). This sounds pleasing to investors and corporate managers especially on the trend of cointregration among Latin American markets especially Brazil and the United States. When it comes to the stock market cycles, financial liberalization and volatility, the stock market is Brazil was found closely related to developed countries (Edwards et al., 2003). Saudi Arabia Conducting business in Saudi Arabia is a sound idea considering that oil still remains as its major asset. Knowing the fact that oil is a major commodity in a growing modern economy, it is important to grab the opportunity investing in Saudi Arabia. However, aside from this consideration, there are other major important factors that need to be considered why it is good to conduct business in Saudi Arabia and among of them are the country’s existing licensing policy, recruitment process, the political and legal structure and dominant societal values (Haniffa and Hudaib, 2007). This is to say that for investors and corporate mangers it is best to look at the Saudi Arabia’s cultural context as far as engaging with its stock market is concerned. According to Oxford Business Group (), Saudi Arabia has the following unrivalled strengths which make it a cut above the other and create positive impact in its economy. These strengths involved a well protected country and economy, promising growth, key sectors, petrochemicals, construction, services and tourism, competitiveness, private sector, labour and outlook. In fact, Saudi Arabia is the economic powerhouse in the Arab world and as such it is well protected. The highly conservative policy of Saudi Arabia ended with it having enormous oil reserves. Even in the time of recession, the government managed to create expansionary fiscal policy and managed to construct infrastructure, education, health and agriculture which ensure self-sufficiency and thus it can manage to be protected from economic downturn in the world. Another point is that Saudi Arabia consists of nearly 24 million people having an average per capita income of $19,895. This implies remarkable and substantial demand for products and services. All of these are positive indicators of a healthy economy of Saudi Arabia. However, the poor sentiment within the country is considered to be the particular reason of its stock market downfall in 2006 and in 2008. This poor sentiment may be due to reliance of oil sector trying to lead the fundamentals in the economy but this only proves that other sectors also have significant influence. Economic growth in Saudi Arabia remains constant and this stability is a good consideration that the health of economic condition remains to be relatively good from 2008 to 2009. Another point is that Saudi Arabia provides better opportunity for its Small Medium Enterprises as key sectors providing more opportunity for the country to produce and export products and services into the Arab world. This makes Saudi Arabia to remain self sufficient despite the existing competition in neighboring Asia and existing economies in the world. Another advantage of Saudi Arabia is its access to cheap fuel which has existing benefits to access to petrochemicals used in the production of pesticides, fertilizers, plastics and aluminum. Construction sector continuous to improve given the fact that house shortages and increase in population remain to be good business opportunities in Saudi Arabia. The increasing number of wealthy people in the kingdom is a promising opportunity for service industry. This means that more and more people are in demand for various essential services. On the other hand, tourism remains a good business opportunity for Saudi Arabia especially on religious tourism as well as domestic tourism. The Government of Saudi Arabia aims to be among the top 10 countries in the world. This is a remarkable indication of trying to tap the country’s potential in order to competitive. In fact, the Saudi Arabian General Investment Authority (SAGIA) was responsible for setting the country as among of the top 10 countries in the world. The private sector in Saudi Arabia contributes positively to the current economic advantage in the country. In fact, the private sector is expected to grow in the days and years to come. However, one major problem that may hinder such growth in the private sector is projected to be in line with financing. Saudi Arabia has essentially positive outlook. With this, the country is maintaining to stand on its ground while continuing to reach its vision. This essentially tries to strengthen them even in times of economic downturn. In fact, Saudi Arabia was able to maintain government spending even in times of economic downturn. Jordan The present economic condition in Jordan was brought by two stages that happened in its history (Sha’sha, 1991). The first was during the time of Prince Abdullah Ibn al Hussein which lasted until 1973. This stage was the foundation on creating modern Jordan. The second stage was in 1973, which was the planning stage for economic development in Jordan. All essential components of this plan such as the implementation process continue until recent time creating more positive development in Jordan’s economy. Jordan’s mixed economy is played by both private and government sector and they have important roles to play (Sha’sha, 1991). Prior to playing their important roles, it is important to consider the evolution that had taken place which included the leadership of economic activities affecting the orientation of economic activities of the country, the significance of the private sector’s role compared to public sector activities, the level of influence of the private sector into the nature of the market and the level of influence of the private sector to affect local politics and economy. So far, everything is traceable to Jordan’s historical development and organizational structure of the private sector. Private sector indeed played the major roles in order for Jordan to substantially create interest for its economy. South Africa One of the most important consideration and an important factor to affect South Africa’s economy is in line with its agrarian development and change, which in particular would include its ability to consider land reform program for its sustainability in agriculture (Stock, 2004) As its primary task, South Africa needs to consider geographical consideration so as to encourage large-scale capitalist agriculture. This is one of the major considerations and definitely has a great impact for the development of its growing economy. Part of this transition is the consideration of financial intermediation across farmers in South Africa through implementation of policies which come in favor of the local farmers (Piesse et al., 2005). Another consideration can be traced to its history. The racial inequality is part of it and contemporary issues are around the edge of sustainability which creates saturated focus on energy, poverty and energy (Buscher, 2009). Contemporary issues are significant considerations considering that it tries to focus on South Africa’s energy, poverty and energy issues. These are all important considerations so as to come up with specific economic growth in the long run. This is one way of saying it that the country is recently on the edge of trying to walk on a new transition which significantly considers its growth particularly on economic consideration. Poland The following are factors considered to improve investment in Poland: productive labour force, wage and other labour cost, treatment of tax that can be afforded to business activity, predictability of the regulatory environment, administrative problems in line with business activity and enforcement of existing law to property rights (OECD, 2004). Poland undergoes post-socialist economic transition at industry level (Kennedy, 1997). Different sectors have experienced the same patterns of transformation. Kennedy was able to identify two distinct patterns and the first group of sectors accomplished restructuring through firm turnover. It was also found that the economic incentives in 1990 during “Big Bang” reforms became sufficient in the promotion of restructuring in the first group. The second group on the other hand had lagged restructuring output. This was due to the fact that industry restructuring was held by a slow-moving progress in restructuring large state-owned enterprises. There were several explanations for this and possible implications. Several ideas on the transitional pattern of Poland are discussed by Cohen (1999). Services sectors were relatively low compared to Western Europe. Poland is much less regressive in primary income distribution compared to West European countries as far as distribution biases are concerned. This implies that the government’s role is less of a redistributionary instrument in a planning-oriented system compared to a market-oriented system. Malaysia Based on its history, Malaysia is a picture of a market with volatile nature of exports and capital flows (Tseng and Corker, 1991). Structural, political and economic problems are considered important factors in consideration in the investment process but there can be more certain factor and that is the lack of information needed in order to make careful evaluation upon investing (Saudagaran, 2009). All of these factors are considered by Malaysia and these boil down to the fact that based also on a report, it is among with other Asian countries that was able to apply quality financial and auditing in emerging economies as vital infrastructure for the growth of emerging markets (Saudagaran, 2009). Globalization of financial market is deemed important in the evaluation of investment opportunity. Liberal economic policies of Malaysia are admired as significant part of its economic growth. However, there is more important than this and according to Ritchie (2005), there is a need to correct ethnically based economic inequality to create national heavy industries and give substantial opportunity for politically well-connected entrepreneurs. The analysis of Ritchie created a significant result that the mix of liberal and illiberal economic policies can balance competing coalitional interests. With policies in line with this, it can lead to country’s economic growth enough to support redistributive politics but stunted growth on technological development. This leaves Malaysia behind China when it comes to technological advancements and Singapore, East Asian NICs or OECD countries when it comes to competency as a nation. Peru In Particular, Peru needs to be studied from the point of view of its rural development and there are specific factors that need to be scrutinised as far as developing its market potential is concerned. From a study, education seems to have a positive impact on labour hours experienced by farm households and this depends on the local market development. Therefore, by improving market access, considerable returns to education are viewed possible (Laszlo, 2008). According to Figueroa (2008) economic elites play significant roles in the economic growth. The theory of economic elites finds its important uses in explaining important facts about the Third World. Peru was found to be consistent in the theoretical model of economic elites. Economic growth depends on the competitiveness of the economy which depends on entrepreneurial capitalists. As found in the study of Figueroa, the entrepreneurial capitalists depend on the circulation of elites. Peru therefore is known to have significant improvement in its economy by being so concerned on issues related to special social concerns. There is a specific consideration of education and not only that; there is a need or consideration on the distribution of elites who are capable enough to determine the number of entrepreneurial capitalists. Argentina In the case of Argentina from 1989 to 1991 there are essential factors that were considered to be important prior to attracting overseas capital and these involved privatisation of large scale enterprises, gaining attention from international equity investment and project finance from foreign banks (Mukherjee,1992). These steps have considerable impact to the growing economy of Argentina. The government cooperation was therefore encouraged for this undertaking. This was to ensure that political risk, residual risk and unknown economic risks will essentially be managed in the event when each or all of them may strike. Recently, a study found macroeconomic indicators such as exchange rates, interest rates, industrial production and money supply create important implication for the decision-making process of investors and corporate managers (Abugri, 2008). However, economic growth was also able to generate regional and social inequalities in Argentina (Salvatore, 2004). This can be traceable to its history in which the greatest factors to contribute in its current economic condition were World War I and the Great Depression. Even so, the country was still able to manage its growth. Argentina is also known as a food-rich export economy. As such, there is a significant need for it to reconsider the nature of its investment with regards to its food-rich export economy. Turkey Public investment was the government’s main contribution to the growth of Turkey (Barth et al., 2000). Government current account balance and current expenditure created significant impact on growth. This is to say that the government was able to provide systematic improvement for its country by creating intelligent and wise decision regarding its financial capabilities. On the other hand, the real GDP in Turkey is affected by primary energyu supply and environmental factors such as CO2 consideration (Karanfil and Ozkaya, 2007). This would mean that Turkey’s economy is heavily dependent on energy in order to sustain the growth of its economy. In the modern age of economic development, Turley is able to grow by placing large consideration on its environment and economy. This sounds a dilemma knowing the fact that it needs energy to obtain economic growth. However, there is also consideration on its environment which at some point tries to hold back some moves toward economic growth. Turkey is also known as a highly inflationary small open economy (Berument, 2007). As such, there is a need to consider more basic understanding of its interest rate and depreciation rate between local currency and the bank, which the bottom line is to understand income, prices and appreciation of local currency. The effects for prices and exchange rate are said to be permanent but it is transitory for income. Pakistan Pakistan focused on capital markets in order to attract investment promotion and economic development by creating streamline for its taxation system on dividend income of foreign investors, extension of the tax exemptions on capital gains, and asking private sectors to launch open-end mutual funds and more (Pakistan economic survey 2004 -05, 2009). On the other hand, there is a need to focus on education which in particular should be in line with business educations. Pakistan considers modernization of education in general and of economic education. Thus, there is a need to understand contemporary approach in education, agreements on business and education and perspectives on the current state of education in Pakistan (Khan and Naru, 2006). Financial literacy is therefore important in Pakistan in order to contribute to the rapid development of businesses and create dramatic improvement on its economy. Business literacy is therefore important prior to gaining substantial financial literacy in the long run. It is important to consider that the market opportunity in Pakistan will depend on the business opportunity of every concerned. This is a remarkable consideration and with the focus on education system particularly on business, there is a considerable improvement on the economic growth in Pakistan in the long run. Venezuela Venezuela relies heavily on foreign trade. It is known for its lowering of tariff walls, reducing it quantitative trade restrictions and devaluating its currency (Pingh and Varshey, 2006). These are great concerns of the masses for these can directly affect their welfare. Another trademark of Venezuela’s economy lies on its vast natural resource which significantly contributed greatly to its economic and energy-use patterns (Bustillos and Segnini, 1991). This is to say that the country has undergone various opportunities in improving the efficiency of energy use in Venezuela and restraining the growth of energy-related carbon emissions. With this approach, Venezuela has undergone the steps which involved improvement of the economy and at the same time switching to efficient use of energy. Thus, in order to develop its economy even more, Venezuela needs to introduce carbon restraints as an integral part of its economic development process (Bustillos and Segnini, 1991). Venezuela is going with the trend in the world and as such, there is a great consideration on its ability to adapt to the current trend which encompasses protection for the environment while demanding greatly on efficiency. This is not going to be easy, but the good thing is that there is an existing demand for such of this activity considering that it is not only Venezuela that tries to adapt this kind of strategic process. Review of Related Literature The following are review of available related literature discussing about the elements or factors that affect emerging stock markets and analysis of the effects of oil prices on emerging stock markets. Elements or factors that affect emerging stock markets Oil as the basic commodity in the modern economy is considered to have significant effect in emerging stock markets (Basher and Sadorsky, 2006). In general, it is not only oil prices that may possibly affect the stock market but there are other factors, which are also worth of consideration. According to Madura et al. (1997), the most relevant factor that could explain returns across stock markets is the country risk. From emerging economies around the world, cultural distance was found to have positive impact in international stock market comovement (Lucey and Zhang, 2010). It was found that country pairs tend to have high linkages if they have smaller cultural distance. This impact was found significant between active-trading pairs than thin-trading country pairs. Chen (2009) found that macroeconomic variables such as interest rate spreads, inflation rates, money stocks, aggregate output, unemployment rates, federal funds rates, federal government debt, and nominal exchange rates can easily predict bear markets. It was also discovered that yield curve spreads and inflation rates are meaningful predictors of recession especially in the case of US stock market. Price and production have important relationship which affects in general the market trend in addition to other significant related consideration. In the case of Turkey’s The Aegean Lignite Enterprise, the price of lignite decreases or increases depending on the industrial production and other consideration such as total electricity production and electricity price (Uner et al., 2008). Thus, in an economic world, the main product of concerned for investment is not only the essential consideration but other related products that may be complementary or substitute. Madura (2008) explained in detail the components and other important elements in the stock market and below are important concepts he was able to discuss. The required rate of return is important in the same way as economic factors affecting risk-free interest rate with respect to the pricing of debt securities. Stock market participants are also important consideration because they need to monitor indicators that can affect risk-free interest rate which eventually has direct effect on the required return of an investor investing on a particular stock. Indicators of inflation and government borrowing also affect the risk-free rate affecting the required rate of return of investors. Indicators of inflation are consumer price index and produce price index. Government borrowing on the other hand includes budget deficit and volume of funds borrowed. This is to say that pressures are always on the part of investors whenever indicators signal high expectation of interest rate because of considering required rate of return. In addition, economic conditions, industry conditions and firm-specific condition are said to influence firm’s expected cash flow. The effects of oil prices on emerging stock markets Fluctuation of oil price is no longer a new issue. However, even if it is faced by the business for such a long period of time now, interesting strategies continue to exist just to stabilise price increase and so as not to hinder the growth of emerging stock markets. Oxford Business Group (2009) reported that Saudi Arabia remains to have a constant growth in its GDP from 2008 to 2009. GDP growth is affected by the impact of volatile oil prices on the value of production. Production therefore has a great impact on oil prices. The production however is affected by the level of demand in the world market in general. Price of oil may rise and fall. In the event that it will rise, the most important consideration is to consider tax reduction but it may only worsen the case and this brings to the fact that it is important to come up with policies that will help increase the price elasticity of demand (De Santis, 2003) It is worth to understand the relationship that exists between oil prices, exchange rates and emerging stock market price due to the fact that emerging economies are growing and aiming to prosper. According to the estimate of Cheng et al. (2007), 50% of GDP by 2050 will be accounted to emerging economies. The growth of these emerging economies will certainly demand for more energy products such as oil. Shown in Graph 3 is the trend of oil consumption from Asia, Middle East, Latin America, Central Europe and Africa from 1984 to 2009. It is remarkable that Asia, Middle East and Africa have the largest consumption or demand for oil. This is just a clear indication that more emerging markets are found in the regions of Asia, Middle East and Africa. This is the other way of saying that the opportunity for investment is found in these regions. There is a common observation that the impact of oil prices on the stock market might be in an inverse proportion as far as their relationship is taken into account. This means that as the oil price goes into an upward spiral, the stock market’s performance will inversely take a plunge. In the same way, it is viewed that as the oil price decreases, the stock market will obtain a higher stock market return. There is a remarkable insight into this especially if the magnitude increase of oil price reaches 50% up to 100% yearly. This can probably be explained by the common observation that any movement in oil prices end up some sort of ambiguity in the stock market. Then as observed in some economy, the higher the oil prices resulted to increase of costs in transportation, production and heating. In a hypothetical example this would mean that a 10% decrease in oil prices will significantly lead to a double expected rate of return in the stock market in a certain time or perhaps in the following month. This can be significantly realised when it would try to create an impact on the world market index. It is certain from the behavior of relationship between oil price and stock market to move in opposite direction. However, this does not necessarily mean that stock market returns can create an impact on crude oil’s prices. There are some common observations that the entire stock market does not necessarily get the impact of fluctuating oil prices. In the US, it is the industrial sector that is widely viewed to get the direct impact of fluctuating oil prices. The other US industrial sectors for instance that get the most impact of oil prices are general retailers, support services, media, entertainment, leisure, hotels and transport. They are followed by household goods, textiles, automobiles and parts. These are then followed by investment companies, banks, life assurance and insurance, real estate, other specialty and finance. Thus, some experts would advise that during oil price there is a need to tap on energy stocks with general market retailers. This is considered a good approach considering that the rise of oil prices can remarkably increase fuel price, lubricants, and cost of transportation. This situation only brings forward the momentary eradication of interest rates and the fast-paced diversion of the disposable incomes in response to spiraling high household energy bills. However, there can be significant reason to think that expenses on discretion are a less covered. Thus, when it comes to stock investments consideration, it is better to ward off mass market retailers. Is there really a direct effect of oil price in the stock market? As stated earlier, there is a common notion that as oil price increases, the stock market falls down to take a deeper plunge. This relationship would imply negative correlation. To illustrate this, Pescatori and Mowry (2008) believed that it might be true that more expensive fuel can lead to higher costs in transportation, production and heating, which would imply decrease of corporate earnings. In the same way, this will also trigger the idea of inflation and warn consumers of their spending. However, they also believed that expensive crude can also be a significant indicator of an improving or growing economy. Thus, higher prices can be a reflection of a strong business performance and rising demand for fuel. The idea of inverse relationship or negative correlation between stock market and oil prices may be observed in Graph 1 presented by Pescatori and Mowry (2008). However, as interpreted by Pescatori and Mowry, there is a remarkable reason to believe that the relationship between oil price and stocks appears to be not so strong. They found out that oil prices and S&P 500 index have frequently moved in opposite direction. To justify this further, they created a scatter plot diagram shown in Table 1 indicating the data points between stock market growth and oil price. In fact, if there is an inverse relationship that exists between the two variables, the scatter plot trend must be aligned in a downward-slope plot. However, the plot shows no clear line of slope trend which only justifies that the two variables do not necessarily have a strong inverse relationship. Finally, in order to generate a statistically in line argument, the best way to do is to test the relationship through statistical correlation tool. As shown in Table 2, there are remarkable statistically significant negative correlations. However, the values are very small which only justify the fact that stock market and oil price do not necessarily have a strong inverse relationship. On the other hand, Basher and Sadorsky (2006) found a strong evidence to suggest that oil price risk creates an impact on stock price returns in emerging markets. Their findings were significant contributions to existing literature regarding the effect of oil price in stock market of emerging markets. In relation to this, there was also significant finding that oil price movements and stock prices indeed vary according to firm size and this relationship is even stronger for medium-sized firms (Sadorsky, 2008). Graph 1: Graphical relationship between oil price and stock market. Source: Pescatori and Mowry (2008). Federal Reserve Bank of Cleveland. Note: The oil price is the weekly average domestic spot price of light sweet crude oil (WTI). The S&P 500 index values are taken from the average weekly close. Table 1: Scatter plot of oil price and S&P Growth. Source: Pescatori and Mowry (2008). Federal Reserve Bank of Cleveland. Note: The sample period is January 1998 – August 2008, and the data are weekly. Table 2. Correlation Between Oil Price and Stock Index Growth (daily)   S&P 500 S&P Industrial Index S&P Financial Index NYSE Composite Dow Jones 30 Industrial Average NASDAQ Dow Jones Transportation 1998-1999 0.028 0.048 −0.029 0.043 0.032 0.057 −0.110 2007-2008 −0.095 −0.020 −0.244 −0.003 −0.140 −0.132 −0.210 Source: Pescatori and Mowry (2008). Federal Reserve Bank of Cleveland. Eryigit (2009) supported the findings of Basher and Sadorsky (2006) by pointing out that oil price changes created significant impact on real economic activities. Eryigit was able to consider all together the energy sectors such as electricity, oil, gasoline, coal, renewable energy, then financial markets, real economy and overall economy. This was to ensure that the economic growth can be best explained. Real economic activity and employment were found to be affected by oil price changes. It was also found that oil price changes and shocks are important tools that can help explain stock price changes. As a whole, oil price changes was found to have statistically significant effects on electricity, wholesale and retail trade, insurance, holding, investment, wood, paper, printing, basic metal, metal products, machinery and non-metal and mineral products at 95% level of confidence. Part of this finding was the positive effect of oil price changes on wood, paper and printing, insurance and electricity sub-sector indices. This only proves that not all sectors in the stock market are affected by oil price changes for it may also bring positive impacts to other sectors. The countries used in the study were Turkey, China, India and USA. In a theoretic sense of the issue, oil prices have important impacts in stock prices in many ways. At any point in time, the price of a company’s share is equivalent to the expected present value of future discounted cash flows (Huang et al., 1996). Oil prices may create a direct impact on stock prices through future cash flows or through an interest rate in discounting future cash flows. In the case of production, the spiraling high price of oil triggers an increase of the cost in doing business and non-oil related business actually reduces profits. The higher price for final goods and services is what the customer will receive especially in times when oil prices are increasing. This will reduce the demand for final goods and services and once again reduce profits. Policy makers often see increasing oil prices as inflationary and central banks usually respond to this pressure by raising interest rates which eventually will affect the discount rate used in the formula for stock pricing. Aside from the above information given which is to be used to describe the relationship between oil price and the growth of stock market, it is also important to study the behavior of consumption of an emerging market. Venezuela for instance was affected by drop in oil prices because the country did not focus on oil export (Perry and Lederman, 1998). This was also aggravated by the fact that fall of oil-related revenues would mean decreasing trend of oil-related investment and thus resulted to reduction of rate of growth. This therefore is significant information considering that oil is vital to modern economy. This proves the fact that every nation is trying to ensure enough supply of oil so as not to be affected with the impact of oil price increase. This can also be a clear proof why for instance there was a remarkable increase of oil reserved within three decades as shown in Graph 2. Considering that the demand is increasing, there is a positive indication that the countries that are highly affected by oil price increase are ensuring not to be affected by its impact. The most essential advantage that is possible is to consider increasing export and use them as reserved. This is quite clear in the case of the United States that is why oil reserved is very important in order to create more economic advantage. Oil price increase at some point may never have direct impact on the stock market but the bottom line is that it may able to contribute changes to some significant components in the stock market. In 1973, oil price increase was responsible or contributed to the unfortunate stock market crash as a result of inflation pressure and the collapse of monetary system. That was the case when oil exporting companies were able to control prices of vital commodities to increase their revenue. Such event of oil shock contributed an advantage to oil exporting companies. This is clear that oil as the basic commodity in modern economy is able to control the faith of an emerging stock market. Industrial production was one of the main sectors greatly affected by the remarkable oil shock in 1973 due to increase in oil prices (Arouri et al., 2010). This is just a clear implication that increase in oil price may not necessarily create direct impact on stock market but on the process it tries to affect some vital parts and such would bring remarkable impacts. In fact, those countries lacking with enough financial capacity are the first to experience economic recession paralising further the healthy flow of their economy. Graph 2. Distribution of proved reserves in 1989, 1999 and 2009. Source: BP Statistical Review of World Energy 2010. Graph 3. Oil consumption by region from 1984 to 2009. Source: BP Statistical Review of World Energy 2010. The following are additional findings and supporting evidences specifying the effects or significant impacts of oil prices on stock market. The basic understanding of international oil prices and its effect to the emerging market can be basically understood from the law of supply and demand curve (Stevens, 1995). Thus, an increase in oil price creates significant impact on the nature of supply and demand of oil. The study of Filis (2010) found that there is a positive effect of oil prices and stock market on Greek CPI. From the cyclical component analysis of the study, it was found that oil prices have contributed negative influence to stock market. Thus, at significant level, oil prices negatively influenced CPI. But there was no significant effect of oil prices on industrial production and CPI. Using the Cheung-Ng approach, the world oil prices Granger in Turkey caused electricity index and adjusted electricity index returns in variance however not on the aggregate market index returns (Soytas and Oran, 2010). On the other hand, the study of Soytas et al (2009) presented that there was a transitory positive initial impacts of oil prices innovation on gold and silver markets respectively. Findings of the study of Aloui and Jammazi (2009) suggest that rises in oil price contributed significant role in the determination of volatility of stock returns and the probability of transition across regimes. Miller and Ratti (2009) studied the relationship of oil price and international stock markets using data from 1971 to 2008. The result suggests that stock market indices created negative response to increase in the oil price in the long run. Nandha and Hammoudeh (2007) studied the relationship between beta risk and realized stock index return with the presence of oil and exchange rate sensitivities for 15 countries in the Asia-Pacific region with the aid of international factor model. Part of the results was that no country showed sensitivity to oil price in US dollar in either the market is up or down. Billmeier and Massa (2009) found that the market capitalization in countries that are known to be rich in resources is driven by oil price. Kretzschmar and Kirchner (2009) showed that companies with oilfield assets which are owned under progressive production sharing fiscal terms have the inability to capture the good it brings for oil price increases. The empirical evidence of the study of Chen (2010) on the Standard & Poor’s S&P 500 price index found that increase in oil price results to a higher chance of a bear market emerging. Driesprong et al. (2008) found significant predictability of oil prices in stock market returns from both developed and emerging markets. Goriaev and Zabotkin (2006) were able to analyse the risk in investing in the Russian stock market. They documented considerable factors and one of them was the oil prices. The main findings of Arouri and Nguyen (2010) revealed that stock returns to oil price changes created great variation depending on the activity sector. Narayan and Narayan (2010) were able to come up a model which explains the impact of oil prices on Vietnam’s stock prices for the period of 2000 to 2008. They found that the cointegration of stock prices, oil prices and nominal exchange rate have a positive and statistically significant impact between stock prices and oil prices. The study of Malik and Ewing (2009) which utilises data from 1992 to 2008 had significant finding that there was significant transmission of shocks and volatility between oil prices and some market sectors implying that investors were into cross-market hedging and sharing of common information. There was strong evidence on the study of Cifarelli and Paladino (2010) that oil price shifts are negatively related to stock price and exchange rate changes. The impact of oil prices on an oil-importing developing economy according to Schubert and Turnovsky (2009) depends on the economy’s internal production and structure. Consequent instability and lower prices for oil were predicted to be the bottom line of a significant discontinuity as the result of fundamental changes in the international oil market (Stevens, 1996). Chevillon and Rifflart (2009) on the other hand have quantified the overall impact brought by the worries outside of physical markets which were able to cause the increase in oil prices. This proves the fact that there are quantifiable results that need to be understood as far as increase in oil prices is concerned. From a study of economic growth and oil price in Pacific Island countries, it was found that oil price, gross domestic product and international reserve are conintegrated (Jayaraman and Choong, 2009). Thus, any significant changes in oil price imply corresponding changes in gross domestic product and international reserve. In China, oil price shock does not show any statistically significant impact on real stock returns but on manufacturing index and some oil companies (Cong et al., 2008). However, it was observed that oil price shock can better explain manufacturing index than interest rates. On the other hand, Apergis and Miller (2009) found that international stock market returns do not respond greatly to oil market. According to Papapetrou (2001) from empirical evidence, oil price changes have significant impact on real economic activity and employment. Furthermore, oil prices can eventually explain stock price movement. From 1986 to 2005, oil price shocks contributed a statistically significant impact on real stock returns in the US and 13 European countries (Park and Ratti, 2008). According to the result of the study of Oberndorfer (2009) oil price hikes have negative impact on stock returns of European utilities. References Abugri, B. A. (2008) ‘Empirical relationship between macroeconomic volatility and stock returns: Evidence from Latin American markets’. International Review of Financial Analysis, Vol. 17(2): 396-410. Aloui, C. and Jammazi, R. (2009) ‘The effects of crude oil shocks on stock market shifts behaviour: A regime switching approach.’ Energy Economics, Vol. 31(5): 789-799. Arouri, M. E. H., Jawadi, F. and Nguyen, D. K. (2006) The Dynamics of Emerging Stock Markets: Empirical Assessments and Implications. New York: Physica-Verlag. Arouri, M. E. H. and Nguyen, D. K. (2010) ‘Oil prices, stock markets and portfolio investment: Evidence from sector analysis in Europe over the last decade.’ Energy Policy, Vol. 38(8): 4528-4539. Audzeyeva, A. and Hoppe, K. R. S. (2010) ‘The role of country, regional and global market risks in the dynamics of Latin American yield spreads’. Journal of International Fianncial Markets, Institutions and Money. Apergis, N. and Miller, S. M. (2009) ‘Do structural oil-market shocks affect stock prices?’ Energy Economics, Vol. 31(4): 569-575. Barth, R., Hemphill, W.,Aganina, I. and IMF Institute. (2000) Financial Programming and Policy: The Case of Turkey. Washington DC: International Monetary Fund. Basher, S. A. and Sadorsky, P. (2006) ‘Oil price risk and emerging stock markets’. Global Finance Journal, Vol. 17(2): 224-251. Berument, H. (2007) ‘Measuring monetary policy for a small open economy: Turkey.’ Journal of Macroeconomics, Vol. 29(2): 411-430. Billmeier, A. and Massa, I. (2009) ‘What drives stock market development in emerging markets – institutions, remittances, or natural resources?’ Emerging Markets Review, Vol. 10(1): 23-35. Buscher, B. (2009) ‘Connecting political economies of energy in South Africa.’ Energy Policy, Vol. 37(10): 3951-3958. Bustillos, N. P. de and Segnini, A. M. (1991) ‘Energy efficiency, carbon emissions and economic development in Venezuela.’ Energy Policy, Vol. 19(10): 946-952. Chen, G., Firth, M. and Rui, O. M. (2002) ‘Stock market linkages: Evidence from Latin America’. Journal of Banking & Finance, Vol. 26(6): 1113-1141. Chen, S. S. (2009) ‘Predicting the bear stock market: Macroeconomic variables as leading indicators’. Journal of Banking & Finance, Vol. 33(2): 211-223. Chen, S. S. (2010) ‘Do higher oil prices push the stock market into bear territory?’ Energy Economics, Vol. 32(2): 490-495. Cheng, H. F., Gutierrez, M., Mahajan, A., Shachmurove, Y. and Shahrokhi, M. (2007) ‘A future global economy to be built by BRICs’. Global Finance Journal, 18: 143-156. Chevillon, G. and Rifflart, C. (2009) ‘Physical market determinants of the price of crude oil and the market premium.’ Energy Economics, Vol. 31(4): 537-549. Christofi, A. and Pericli, A. (1999) ‘Correlation in price changes and volatility of major Latin American stock markets’. Journal of Multinational Financial Maangement, Vol. 9(1): 79-93. Cifarelli, G. and Paladino, G. (2010) ‘Oil price dynamics and speculation: A multivariate financial approach.’ Energy Economics, Vol. 32(2): 363-372. Cohen, S. I. (1999) ‘European structural patterns applied to transition economies: assessment for Poland and Hungary.’ Socio-Economic Planning Sciences, Vol. 33(3): 205-219. Cong, R. G., Wei, Y. M., Jiao, J. L. and Fan, Y. (2008) ‘Relationships between oil price shocks and stock market: An empirical analysis from China.’ Energy Policy, Vol. 36(9): 3544-3553. Diamandis, P. F. (2009) ‘International stock market linkages: Evidence from Latin America’. Global Finance Journal, Vol. 20(1): 13-30. Driesprong, G., Jacobsen, B. and Maat, B. (2008) ‘Striking oil: Another puzzle?’ Journal of Financial Economics, Vol. 89(2): 307-327. Edwards, S., Biscarri, J. G. and Gracia, F. P. de. (2003) ‘Stock market cycles, financial liberalization and volatility’. Journal of International Money and Finance, Vol. 22(7): 925-955. Eryigit, M. (2009) ‘Effects o oil price change on the Sector Incdices of Istanbul Stock Exchange’. International Research Journal of Finance and Economics, (25): 209-216. Filis, G. (2010) ‘Macro economy, stock market and oil prices: Do meaningful relationships exist among their cyclical fluctuations?’. Energy Economics, Vol. 32(4): 877-886. Figueroa, A. (2008) ‘Competition and circulation of economic elites: Theory and application to the case of Peru.’ The Quarterly Review of Economics and Finance, Vol. 48(2): 263-273. Goriaev, A. and Zabotkin, A. (2006) ‘Risks of investing in the Russian stock market: Lessons of the first decade.’ Emerging Markets Review, Vol. 7(4): 280-297. Haniffa, R. and Hudaib, M. (2007) ‘Locating audit expectations gap within a cultural context: The case of Saudi Arabia’. Journal of International Accounting, Auditing and Taxation, Vol. 16(2): 179-206. Huang, R. D., Masulis, R. W. and Stoll, H. R. (1996) ‘Energy shocks and financial markets’. Journal of Future Markets, (16): 1-27. Huang, W. X. (2007) Institutional Banking for Emerging Markets: Principles and Practice. England: John Wiley & Sons. Jayaraman, T. K. and Choong, C. K. (2009) ‘Growth and oil price: A study of causal relationships in small Pacific Island countries.’ Energy Policy, Vol. 37(6): 2182-2189. Karanfil, F. and Ozkaya, A. (2007) ‘Estimation of real GDP and unrecorded economy in Turkey based on environmental data.’ Energy Policy, Vol. 35(10): 4902-4908. Kennedy, R. E. (1997) ‘A tale of two economies: Economic restructuring in post-socialist Poland.’ World Development, Vol. 25(6): 841-865. Khan, S. M. and Naru, A. M. (2006) ‘Modernizing economic education in the global economy with reference to Pakistan.’ Journal of Asian Economics, Vol. 17(5): 904-922. Kretzschmar, G. L. and Kirchmer, A. (2009) ‘Oil price and reserve location-Effects on oil and gas sector returns.’ Global Finance Journal, Vol. 20(3): 260-272. Laszlo, S. (2008) ‘Education, Labor Supply, and Market Development in Rural Peru’. World Development, Vol. 36(11): 2421-2439. Lucey, B. M. and Zhang, O. (2010) ‘Does cultural distance matter in international stock market comovement? Evidence from emerging economies around the world’. Emerging Markets Review, Vol. 11(1): 62-78. Madura, J., Tucker, A. L. And Wiley, M. (1997) ‘Factors affecting returns across stock markets’. Global Finance Journal, Vol. 8(1): 1-14. Malik, F. and Ewing, B. T. (2009) ‘Volatility transmission between oil prices and equity sector returns.’ International Review of Financial Analysis, Vol. 18(3): 95-100. Miller, J. I. and Ratti, R. A. (2009) ‘Crude oil and stock markets: Stability, instability, and bubbles.’ Energy Economics, Vol. 31(4): 559-568. Mukherjee, M. (1992) Factors Affecting Private Financial Flows to Eastern Europe, 1989-91. Washington DC: The World Bank. Nandha. M. and Hammoudeh, S. (2007) ‘Systematic risk, oil price and exchange rate sensitivities in Asia-Pacific stock markets.’ Research in International Business and Finance, Vol. 21(2): 326-341. Narayan, P. K. and Narayan, S. (2010) ‘Modeling the impact of oil prices on Vietnam’s stock prices’ Applied Energy, Vol. 87(1): 356-361. Oberndorfer, U. (2009) ‘Energy prices, volatility, and the stock market: Evidence from the Eurozone.’ Energy Policy, Vol. 37(12): 5787-5795. OECD. (2004). Poland. Paris: OECD. Oxford Business Group. (2009) The Report: Saudi Arabia 2009. Saudi Arabia: Oxford Business Group. Pakistan economic survey 2004 -05. (2009) Michigan: Ministry of Finance 2004. Papapetrou, E. (2001) ‘Oil price shocks, stock market, economic activity and employment in Greece.’ Energy Economics, Vol. 23(5): 511-532. Park, J. and Ratti, R. A. (2008) ‘Oil price shocks and stock markets in the U.S. and 13 European countries.’ Energy Economics, Vol. 30(5): 2587-2608. Pescatori, A. and Mowry, B. (2008). ‘Do Oil Prices Directly Affect Stock Market?’ [Online] Available at: http://www.clevelandfed.org/research/trends/2008/0908/04ecoact.cfm.(Accessed: 20 September 2010). Piesse, J., Doyer, T., Thirtle, C. and Vink, N. (2005) ‘The changing role of grain cooperatives in the transition to competitive markets in south Africa’. Journal of Comparative Economics, Vol. 33(1): 197-218. Pingh, V. and Varshey, A. (2006) ‘Managing Globalization: Lessons from China and India: Inaugural Conference of the Lee Kuan Yew School of Public Policy’, In Kelly, D. A., R. S. Rajan and G. H. L. Goh (eds.). India’s Identoty Politics: Then and Now. Singapore: New Scientific Publishing. Ritchie, B. K. (2005) ‘Coalitional politics, economic reform, and technological upgrading in Malaysia.’ World Development, Vol. 33(5): 754-761. Sadorsky, P. (2008) ‘Assessing the impact of oil prices on firms of different sizes: Its tough being in the middle’. Energy Policy, Vol. 36(10): 3854-3861. Salvatore, R. D. (2004) ‘Stature decline and recovery in a food-rich export economy: Argentina 1900-1934.’ Explorations in Economic History, Vol. 41(3): 233-255. Santis, R. A. De (2003) ‘Crude oil price fluctuations and Saudi Arabia’s behaviour’. Energy Economics, Vol. 25(2): 155-173. Saudagaran, S. M. (2009) International Accounting: A User Perspective. 3rd ed. Chicago: CCH. Sha’sha, Z. J. (1991) ‘Politics and the economy in Jordan.’ In R. Wilson (ed.). The Role of the Private Sector in Jordan’s Economy. New York: Routledge. Soytas, U. and Oran, A. (2010) ‘Volatility spillover from world oil spot markets to aggregate and electricity stock index returns in Turkey.’ Applied Energy, Vol. 88(1): 354-360. Soytas, U., Sari, Ramazan, Hammoudeh, S. And Hacihasanoghu, E. (2009) ‘World oil prices, precious metal prices and macroeconomy in Turkey.’ Energy Policy, Vol. 37(12): 5557-5566. Stevens, P. (1995) ‘The determination of oil prices 1945-1995: A diagram interpretation.’ Energy Policy, Vol. 23(10): 861-870. Stevens, P. (1996) ‘Oil prices: The start of an era?’ Energy Policy, Vol. 24(5): 391-402. Stock, R. (2004) Africa South of the Sahara: A Geographical Interpretation. 2nd ed. New York: The Guildford Press. Torre, Augusto de la and Schmukler, Sergio. L. 2007 Emerging capital markets and globalization: the Latin American Experience. USA: The World Bank. Tseng, W. and Corker, R. (1991) Financial liberalization, money demand and monetary policy in Asian countries. Washington DC: International Monetary Fund. Uner, M., Kose, N., Gokten, S. and Okan, P. (2008) ‘Financial and economic factors affecting the lignite prices in Turkey: An analysis of Soma and Can lignites’. Resources Policy, Vol.33(4): 230-239. Read More