Among the biggest forces affecting stock prices are inflation, interest rates, bonds, commodities and currencies. Sometimes the stock market reverses abruptly, usually followed by published explanations formulated to suggest that the writer’s careful observation allowed him to predict market change. Such circumstances leave investors somewhat amazed and amazed by the infinite amount of continuous factual inputs and infallible interpretation needed to avoid market backlash. Although there are continuous sources of input that we need to successfully invest in the stock market, they are limited. If you contact me on my website, I will be happy to share some with you. However, what is more important is to have a robust model for interpreting any new information that appears. The model should take into account human nature as well as the major market forces. The following is a cyclical pattern of personal work that is neither perfect nor comprehensive. It is simply an objective through which the rotation of the sector, the behavior of the industry and the change of market sentiment can be viewed.
As always, any understanding of markets begins with familiar human traits of greed and fear, along with perceptions of supply, demand, risk, and value. The emphasis is on perceptions in which group and individual perceptions usually differ. It can depend on investors to get the highest return for the lowest risk. Markets, representing the behavior of the group, can depend on the excessive reaction to almost any new information. The subsequent spread or relaxation of the price makes it seem that the initial answers have a lot to do with nothing. But no, group perceptions simply oscillate between extremes and prices follow. It is clear that the general market, as reflected in the major averages, affects more than half of the price of a share, while earnings account for most of the rest.
With this in mind, stock prices should rise as interest rates fall as companies become cheaper to finance loan-financed projects and operations. Lower borrowing costs allow for higher gains that increase the perceived value of a stock. In a low interest rate environment, companies can borrow by issuing corporate bonds, offering rates slightly above the average Treasury rate without incurring excessive borrowing costs. Existing bondholders cling to their bonds in a declining interest rate environment as the rate of return they receive exceeds anything offered in newly issued bonds. Shares, commodities and existing bond prices tend to rise in a declining interest rate environment. Loan rates, including mortgages, are closely linked to the 10-year Treasury interest rate. When rates are low, the loan increases, effectively putting more money into circulation, chasing more dollars after a relatively fixed amount of shares, bonds and commodities.
Bond traders continually compare bond yields to bond yields. Inventory return is calculated from the mutual P / E ratio of a stock. Price-shared earnings provide returns. The assumption is that the price of a stock will move to reflect its gains. If the stock returns for the S&P 500 as a whole are the same as the bond yields, investors prefer bond security. Bond prices then rise and stock prices fall as money moves. As bond prices trade more, due to their popularity, the effective yield for a particular bond will decrease because its face value at maturity is fixed. As actual bond yields continue to fall, bond prices are outpacing and equities are beginning to look more attractive, albeit at higher risk. There is a natural oscillating inverse relationship between stock prices and bond prices. In a growing stock market, equilibrium has been reached when stock yields appear to be higher than corporate bond yields, which are higher than Treasury bond yields, which are higher than savings account rates. Longer-term interest rates are naturally higher than short-term rates.
That is, until the introduction of higher prices and inflation. With an increased supply of money in circulation in the economy, due to the increase in loans under low interest rate incentives, it leads to higher commodity prices. Changes in commodity prices penetrate the entire economy to affect all heavy goods. The Federal Reserve, seeing higher inflation, is raising interest rates to remove excess money from circulation, to cut prices again. Borrowing costs are rising, making it more difficult for companies to raise capital. Equity investors, perceiving the effects of higher interest rates on the company’s profits, are starting to lower their earnings expectations and share prices are falling.
Long-term bondholders follow inflation because the real rate of return on a bond is equal to the yield on the bond minus the expected rate of inflation. Therefore, rising inflation makes previously issued bonds less attractive. The Treasury Department must then increase the coupon or interest rate on newly issued bonds to make them attractive to new bond investors. With higher rates on newly issued bonds, the price of bonds with existing fixed coupons decreases, leading to an increase in their effective interest rates. Therefore, both stock and bond prices are falling in an inflationary environment, mainly due to the anticipated rise in interest rates. Investors in domestic stocks and holders of existing bonds find the interest rate low. Fixed return investments are most attractive when interest rates fall.
In addition to having too many dollars in circulation, inflation can also be increased by lowering the value of the dollar in foreign exchange markets. The cause of the recent decline in the dollar is the perception of a decline in its value due to continuing national deficits and trade imbalances. As a result, foreign goods may become more expensive. This would make US products more attractive abroad and improve the US trade balance. However, if before this happens, foreign investors are perceived as considering investments in US dollars less attractive, putting less money on the US stock market, a liquidity problem can lead to lower stock prices. Political turmoil and uncertainty can also reduce the value of currencies and increase the value of hard goods. Stocks do pretty well in this environment.
The Federal Reserve is seen as a goalkeeper walking on a fine line. It can raise interest rates, not only to prevent inflation, but also to make US investment attractive to foreign investors. This applies especially to foreign central banks that buy huge amounts of cash. Concerns about rising rates are holding stock and bond holders worried for the reasons mentioned above and shareholders for another reason. If rising interest rates take too much dollars out of circulation, it can cause deflation. Companies cannot then sell products at any price, and prices fall dramatically. The resulting effect on stocks is negative in a deflationary environment due to the simple lack of liquidity.
In short, for stock prices to run smoothly, perceptions of inflation and deflation need to be balanced. A disturbance in this balance is usually seen as a change in interest rates and the exchange rate. Stock and bond prices normally fluctuate in opposite directions due to differences in risk and the changing balance between bond yields and apparent stock yields. When we find them moving in the same direction, it means that there is a major change in the economy. A fall in the US dollar raises fears of higher interest rates, which negatively affect stock and bond prices. The relative size of market capitalization and daily trading help explain why bonds and currencies have such a large impact on stock prices. First of all, let us consider the total capitalization. Three years ago, the bond market was 1.5 to 2 times larger than the stock market. In terms of trading volume, the daily trading ratio of coins, treasuries and shares was 30: 7: 1, respectively.