Prices of the Stock Market and the Respective Macroeconomic Variables - Coursework Example

THE RELATIONSHIP BETWEEN PRICES IN THE STOCK MARKET AND THE RESPECTIVE MACROECONOMIC VARIABLES Name Course Name of Professor Name of University Submission date Introduction For the last decade capital flows to various stock markets has increased significantly due to the liberalization of different economies and the withdrawal on foreign capital controls. The gradual growth in economies has as a result accumulated funds from developed economies to ensure diversified benefits or higher returns. These capital forms are called the foreign portfolio investment (FPI) and foreign direct investment (FDI). The FDI are long-term while the FPI appears to be short term and its benefits to various economies are doubtful. Of importance to the question is the Stock market which is the center of all transactions. The stock market operations incorporate buyers and sellers of various securities working towards meeting specified price. In this case, therefore, stock market plays an important role in the mobilization of funds for emerging and the developing nations leading to the industrial and commercial growth of various countries. Investors and economic researchers have often focused on the stock markets prices and the fundamental macroeconomic in different economies to provide attractive investment opportunities for the foreign investors and other investment organizations within in a country. Market return response in macroeconomic variables cannot be determined earlier due to the domestic and global variations. Subsequently, these global variables are also more relevant as compared to the domestic variables when explaining returns across different economic markets. These markets are inherently interrelated with various domestic variables, poor policy implementation and the weak macroeconomic environment which has made it impossible even for a single emerging market to be transmittedto the global marketplace. An obvious example is after weakmacroeconomic fundamentals and leverage banks in the emerging economies; their economies experienced increased market volatility and a reduction in market valuations. As a result of these factors, therefore, the fluctuations, exchange rates, money supply and industrial production factors in macroeconomics have a significant influence on stock market prices through their effects on the future prices and the cash flow rates which are also discounted. In this case, therefore, there exist a correlation between the prices in the stock market and the respective macroeconomic variables that can be assessed and investigate. Prices of the Stock market and the respective macroeconomic variables Various research conducted indicates that about 30-35% of the variation in stock market prices are as a result of the economic factors such as money supply, interest rates, fiscal deficit, industrial production among other factors. Market stock variation depends on the behavior of these individual factors. The market index, for example, can be influenced by the macroeconomic variables such as interest rates, monetary supply, inflation in the country, economic growth, Industrial Production, Gross Domestic Product (GDP) and Exchange Rate. Among these factors, the exchange rate has been shown to influence the stock market the most due to the trade effects. A reduction in the domestic currencies which is part of the exchange rate leads to an increase in the volume of exports. However, provided the demand for export remains elastic, there will be an increase in cash flows for the domestic organizations and hence an increase in stock market prices. In this case, therefore, it can be argued that corporate earnings which form a critical component of stock prices, depends on the economic variables such as prosperity and output growth, economic growth, availability of quality workforce and capital stock. Other than these factors, there exist other factors that directly and indirectly affect the economic and prosperity growth which in the long run affects the stock price behavior. Consequently, there exist specific variables used to describe the state of the macroeconomy that each and every investor needs to forecast and monitor. The essence is basically to get the idea of the future corporate earnings, the dividends, and interest payments. Interest Rate and Stock Prices The interest rate is a variable of macroeconomic and is influencedby time factors, default risk, the productivity of invested capital and the rate of inflation in a country. The variation that occurs in the interest rates often encourages substitution of the stock market, speculative activities in the market and the market instruments. According to Bodie, Kane & Marcus (2013), corporate interest rates are often guided by preferred range through various monetary policies in a country. However, in an event a disorganized financial sector, interest rates cannot be regulated and often may rise to higher levels subject to the demand and supply of funds in a given marketplace. In this scenario, investors have to put into consideration the level and growth of interest rates in a prevailing market and other economic sectors. Consequently, it is essential that they evaluate the impact of the growth and level on the performance and the profitability of their companies. Therefore, any increase in interest rate depresses the corporate profitability which also leads to increased discount rates applied to the equity investors. In this case, both issues hurt the stock prices. Increased interest rate is anticipated to impact adversely on the performance of every corporate organization. A study recently conducted in the United States indicates that a slight cut in interest rates or discount rate leads to a jump in the stock prices immediately. Another study on the Korean economy shows a negative relationshipbetween the lasting interest rates and a positive onebetween the temporary interest rates in the economy. Money Supply and Stock Prices Money supply influences the economic activities in a country, and this is the main reason why its regulation is the main function in relation to the monetary authority or agency of any economy across the globe. Money supply is the controlling indicator of success or failure of any economy and affects the economy's stock prices significantly. The main reason for the opinion is that money grows but only if supplemented by growth in output of goods and services which will serve to release inflationary spiral to a given economy. This is expected to reduce stock prices as a consequence and also diversifies capital holdings away from the financial resources such as the stock and shares to the real assets. The change is often initiated in an economy to hedge against certain erosive effects that may be on the financial assets. In this case, therefore, it can be argued that money supply, which is a macroeconomic variable, adversely and significantly affects the stock market prices in an economy. Fiscal Deficits and Stock Prices National governments, in particular through the central budget, play a substantial role in the development of the economy. This isas a result of their involvement in the preparation of annual information on expenditures, revenues, and deficits that are incurred in various government operations (Jones, 2006). All the excess from various government expenditures over the government represents the deficit and has to be financed with the government borrowing in three different ways. First, the national government can opt to borrow from the central government, and this will often lead to an increase in money supply in the country and hence an inflationary impact on the entire economy. The second option involves an option whereby the government can resort to borrowing from the domestic capital market. In this scenario, the domestic interest rates will be pushed and crowd out the private sector investment opportunities. In the third option, the government can decide to borrow from foreign countries which will also influence a given economy’s stock prices. In this case, a budget that has a high surplus or deficit will lead to a debt that can be difficult to service plus a tax structure that provides a disincentive for the given stock market investments. This will be unfavorable to the stock market. These issues related to fiscal deficits have become common on developing nations due to the need to improve their infrastructure and the economic policies that have affected aggregate economic activities and in turn implicated the stock prices. In other words, the budget deficits impact on the stock market activities and hence the stock prices in an economic variable. Industrial Production and Stock Prices Industrial production is the measure of the industrial segment of the economy which includes manufacturing sectors, utilities and mining but contributes to a small portion of the GDP. Industrial production is sensitive to interest rates and the consumer demand hence an essential tool for economic performance. The changes in industrial production have significant effects on the investor’s opportunities and their real value of cash flows. Many investors use the industrial production as a proxy for growth to in gauging the general economic well-being. Any increase in the industrial production impact negatively on the stock prices of an economy. Inflation Rate and Stock Prices According to Brealey, Allen & Myers (2006), the effect of inflation on the economic growth can be described as bi-directional. While some sectors of the economy might not be affected by increased inflation, some tend to suffer more even to the point of collapsing. The relationship that exists between inflation and the stock market is that an increase in inflation increases the stock prices. This stock price is related negatively to both the expected and unexpected consumer price index which involves the measure of changes in the price level of various goods and services and it is assumed that the common stock value need to be the hedge against inflation. Additionally, an increase in inflation cuts the share prices due to the involvement of inflation with various taxing systems. This explains why there has been a substantial decline in stock prices in different markets across the globe. However, investors in various economies have often undervalued corporate stock during the inflation periods since they fail to put into consideration capital gain on the corporate debt that is compatible with the nominal interest rates rather than the real interest rates in the market. Consequently, this is seen as a negative correlation between stock price values and the inflation proportions. Rate of Exchange and Stock Prices The exchange rate is the value at which currencyis convertedin relation to other currencies. In this case, the performance and the profitability of a given economy are determined by the exchange rate of the currency used forthe other leading currencies. This mostly involves exporting and importing companies and the heavy users of imports. The exchange rate is an outcome of external trade activities and is directly interrelated to payment balance in an economy. This payments balance deficits plus the level of exterior reserve affects the currency’s exchange rate which consequently affect stock price behavior. There is, therefore, a progressive correlation that exists between stock prices and the rates of exchange since stock prices and depreciation in the rate of exchange are proportionally related. Gross Domestic Product (GDP) and Stock Prices The Gross Domestic Product (GDP) and economic growth are proportionally related. Any grow thin the growth rate of the GDP with other factors in the economy being equal leads to a more favorable stock market and hence economic growth. Other prices related to equity may rise due to the potential for increased profits in the economy from a healthy business environment. Conclusion There exist an essential correlation connecting stock market prices and the respective macroeconomic variables. The macroeconomic variables including the industrial production, rate of inflation, exchange rate and gross domestic product (GDP) are directly linked to stock market prices of an economy. The investors in various economies need to consider these and other factors the effect the prices of the stock and the main idea is to assess the individual variable and determine whether the changes matters determining the amounts of stock in a given economy. Additionally, it is important to consider re-purchase of shares to provide a positive impact to the investment and hence high commodity prices. Bibliography Top of Form Top of Form Bottom of Form Top of Form Bodie, Z., Kane, A., & Marcus, A. J. (2013). Essentials of investments. New York, NY, McGraw-Hill/Irwin. Brealey, R. A., Myers, S. C., & Allen, F. (2006). Principles of corporate finance. New York, NY, McGraw-Hill/Irwin. Jones, C. P. (2006). Investments: analysis and management. Hoboken, NJ, John Wiley & Sons, Inc. Bottom of Form Bottom of Form Read More