stock prices as economic indiactor
TRANSCRIPT
STOCK
PRICES
Submitted By :- Shruti Pendharkar
ECONOMIC INDICATORS
ECONOMIC INDICATORS Economists, analysts, and even individual investors want to
keep a pulse on the economy. But no one wants to wade through the massive volume of economic statistics that are put out by various entities, both governmental and private.
An Economic indicator is any statistic about the economy which investors use in order to interpret and understand the current and future health of the economy.
They provide measurements for evaluating the health of our economy, the latest business cycles and how consumers are spending and generally faring.
•Where the cycle is going.•change before the general cycle activity.Leading
Indicators
•Where the cycle is now.•change with the general cycle activity.Coincident
Indicators
•Where the cycle has been.•change before the general cycle activity.•Gross Domestic Product (GDP data), Inflation,
Interest Rates, Unemployment Rate and Income & Wealth.
Lagging Indicators
STOCK PRICES
Stock market returns are a leading economic indicator, as the stock market usually begins to decline before the economy declines and begins to improve before the economy begins to pull out of a recession.
This is premised on the assumption that (current) stock prices reflect expected future corporate earnings growth, which in turn is related to future GDP growth.
Stock prices influence consumer and business confidence, which affects the economy. The relationship also works the other way, in that economic conditions often affect stock markets.
It not only signals future changes in the economy but also have direct impact on economic activity.
Price of stock equals present or discounted value of expected future dividends
ATTRIBUTES DESCRIPTIONMeasured By The total market value of goods and services
produced, annual expansion of the size of the economy, and the economic strength of the country relative to other countries.
Significance Reflect economic expectations and investors attitude;
Reliability factor Somewhat unreliable as have probability for false signals
Presented on Individual prices in money and indices of average prices.
Driven By Stock prices are also partially driven by long term microeconomic and macroeconomic variables.
Nature Seasonal, Cyclical and Defensive.
Released Almost continuously round the clock.
WHAT STOCK PRICES REPRESENT?
What Others Will Pay: - Stock prices represent what other investors are willing to pay
at the moment – and which share owners are willing to accept -- for shares of a company.
Financial & Economic Health: - Investors and economic analysts see stock prices as
representing the financial health of a company and a country. There is an indirect link between stock price and financial health.
Rising and Falling: - Changes in stock prices have their own signification. Rising of
stocks can represent a positive growth of a company or country. And falling of prices can represent decline in the growth.
Value and Opportunity: - Stock prices may represent value and an opportunity to predict
future profit and growth.
REASONS FOR STOCK PRICES BEING A LEADING INDICATOR
Two possible reasons why stock prices lead the economy are:
Stock prices reflect expectations of earnings dividends and interest rates.
Stock market reacts to various leading indicator series, the most important being
Corporate earnings Corporate profit margins Interest rates Changes in growth of money supply
STOCK MARKET PRICE INDICES
Index are used to measure changes in stock prices of component companies.
It is used as a measure of the nation’s stock of capital, as well as a measure of future business and consumer confidence levels.
The stock index function as an indicator of the general economic scenario of a country / region / sector.
If the stock market indices are growing, it indicates that the overall general economy of the country is stable and that the investors have faith in the growth story of the economy.
If, however, there is a plunge in the stock market index over a period of time , it indicates that the economy of the country is in troubled waters.
Stock indices can be constructed –
For the entire world ( Global Indices)
For an entire continent ( Regional Indices – for example S&P Latin America 40)
For an entire country ( National Indices – for example Sensex & Nifty for India )
For a particular sector in a country – ( Sectoral Indices – for example BSE BANKEX which tracks top banking companies in India)
For any other theme / group of economy / companies you want to track. ( example Dow Jones Islamic world market index)
STANDARD & POOR'S 500 INDEX - S&P 500 An index of 500 stocks chosen for market size, liquidity and
industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.
Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market value weighted index - each stock's weight is proportionate to its market value.
DOW JONES INDUSTRIAL AVERAGE – DJIA The Dow Jones Industrial Average is a price-weighted average
of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The DJIA was invented by Charles Dow back in 1896.
Often referred to as "the Dow," the DJIA is one of the oldest and single most watched index in the world. The DJIA includes companies like General Electric, Disney, Exxon and Microsoft.
BSE SENSEX: -
The BSE SENSEX (SENSitive indEX)is a basket of 30 stocks representing a sample of large, liquid and representative companies. The base year of SENSEX is 1978-79 and the base value is 100. The index is widely followed by investors who are interested in Indian stock markets.
NSE S&P: -
The NSE S&P CNX Nifty 50 index – a well diversified 50 stock index accounting for 24 sectors of the economy. While both SENSEX and NIFTY would give you an overall direction of the stock market there are other indices which track a particular sector.
INFLUENCING FACTORS OF STOCK PRICES ONECONOMY
There is broad consensus that stock market performance impacts the economy.
•Persistent stock decline can be interpreted as the harbinger of economic slowdown, lowering consumer confidence and the business outlook which, in turn, leads to lower consumption and investment spending
Confidence Effect
•The more the companies rely on the stock market for financing, the more they are held back by bear markets.
Financing Effect
•When the stock market is rising, investors are more wealthy and spend more. As a result, the economy expands.
•On the other hand, if stock prices are declining, investors are less wealthy and spend less. This results in slower economic growth.
Wealth Effect
RELATIONSHIP OF STOCK PRICES WITH OTHER ECONOMIC VARIABLES
INTEREST RATES, INFLATION AND STOCK PRICES
Not direct and consistent.
Cash flow from stocks can change along interest rates, but it’s not certain whether this change will augment or offset the change in interest rate.
Interest rates are directly proportional to inflation.
As there is Increase in inflation, RBI increases the interest rates in order to reduce money supply and slow inflation down.
The effect of interest rate changes on stock prices depends on what caused the change in interest rate.
INFLATION
INTEREST RATE
COST OF PRODUCTION
PROFIT MARGIN
STOCK PRICES(Decline
Significantly)
PROFIT MARGIN
STOCK PRICES (Stable)
Firms Not Able To Cope up
With Increased
Prices
Firms Able To Cope up
With Increased
Prices
MONEY SUPPLY AND STOCK PRICES
Money supply is one of the most basic parameters in an economy and measures the abundance or scarcity of money.
Stock prices tend to move higher when the money supply in an economy is high.
Plenty of money circulating in the economy both makes more money available to invest in stocks and also makes alternative investment instruments, such as bonds less attractive.
An additional reason stocks do well when the money supply is high is the increase in general demand in the economy.
When the borrowing rates are low, mortgage rates also decline, making homes more affordable and increasing demand for such items as TV sets, washing machines and so on. Car sales also go up when the financing rates drop.
The lower rates partially trickle down to interest rates charged on credit card purchases, and consumers purchase more of essentially every imaginable good and service. The result is an increase in sales for most companies, which increases profits and usually results in higher stock prices.
STOCK PRICES & IIP
Industrial production is a coincident indicator.
The reduced consumer spending leads to lower demand situation. The producers respond by cutting down on the production. Low industrial production results in lower corporate sales and profits, which directly affects stock prices. So a direct impact of weak IIP data is a sudden fall in stock prices.
A continuous fall in overall IIP data may lead to many fundamentally strong stocks being undervalued. This gives you the perfect opportunity to invest in fundamentally strong companies at discount price.
Growth in IIP numbers are good signs for cement and steel industries. Mining Sector contributes approx 10% to the IIP. Growth figures can tell us in advance about how mining and steel companies are going to fare in coming quarters.
IIP data is something that investors need to keep track. Indian stock markets are very sensitive to IIP Numbers. A better IIP number would show a positive growth on our Industrial production and stock markets would possibly cheer.
FOREIGN EXCHANGE AND STOCK PRICES
A weak foreign exchange value of the dollar should be conducive to rising stock prices.
A weak or depreciated dollar is associated with healthy export growth and sluggish import growth because, as demand shifts from foreign-produced goods to domestically produced goods, U.S. manufacturers benefit from a depreciated dollar at the expense of foreign manufacturers.
A weak dollar will make it more expensive for U.S. consumers and producers to buy foreign goods, and some are likely to shift to domestically produced goods, which are now lower priced.
At the same time, consumers in other countries may find U.S. products cheaper than their own products and shift their demand to U.S. goods.
RELIABILITY OF STOCK PRICES AS ECONOMIC INDICATORS
Stock market indices, gives a snapshot of how the economy is going forward .It’s just a snapshot.
“Stock market predicted 10 of the last 8 recession.”
Looking at the above chart, it’s hard to believe that stock market is a valid indicator.
Starting in 1960 and using a decline of 10% as some sort of leading indicator would have generated five false positives, one miss, and one success.
at the start of the 1991 recession the S&P was up over 10%, and at the start of the 2001 recession the S&P was nearly flat.
The S&P did not decline 10% before during or after the 1960 recession.
In 1987 and 2003 the stock market declined nearly 20% but there was no recession.
Sources says, these false alarms can be cause of changes in some of internal and external economic environment of the country.
Timing: - Stock prices can determine future economic condition, but at what time. Sources says, stock prices effect on economy can be seen in 1 week or max. 24 weeks.
INDIAN SCENARIO
INDIAN STOCK PRICES AND FOREX
INDIAN GDP AND STOCK PRICE COMPARISON
INDIAN STOCK PRICES AND INFLATION RATE
INDIAN STOCK PRICES AND INTEREST RATES
COMPARISON OF INDIA US
COMPARISON OF INDIA AND CHINA
CONCLUSION
There is a considerable debate, on whether a systematic casual connection exists between stock prices and general economic conditions.
Stock price movement appears to be valuable but infallible leading indicator of business fluctuation, occasionally giving false signals.
Composite use of all LEI can be helpful in broadly examining and predicting the economy of a country.
