If you are a budding and a keen investor, it is very important to know what parameters should your analysis and research be based on. So, before you decide on your next trade, it’s advisable to count on all the company related and external factors to get a better idea of the market movements. This helps any investor to know all events that can influence the price and its impact on the market movements.
The External Major events that can affect the market are briefly discussed as follows.
1) Monetary Policy
The monetary policy of any country can affect the market prices significantly. Monetary policy states the use of financial instruments under the control of RBI to standardize availability of credit, interest rates, money supply to reach the ultimate objective of economic policy. The three objectives of monetary policy of Reserve Bank of India (RBI). The three objectives are:
(1) Price Stability or Control of Inflation
(2) Economic Growth
(3) Exchange Rate Stability.
Reserve Bank of India (RBI) uses this tool, Monetary policy to keep a hold of the money supply by controlling the interest rates. They do this by changing the interest rates and maintaining a balance between the growth and inflation. Every country’s central bank is responsible for fixing these interest rates.
How does RBI policy affect stock market?
Particularly, high interest rates means the borrowing rates are high (for corporations). High interest rates for corporates make it difficult for them to borrow easily and grow economically. If corporations don’t grow, the economy slows down.
On the contrary, Low interest rates, means borrowing becomes easier for corporations and consumers. With more borrowing potential, the sellers can spend more and are more likely to increase prices which further causes inflation.
Thus to avoid any of the above situations, the RBI considers all the factors and sets a few key rates, such as Repo Rate, Reverse Repo Rate, Cash Reserve Ratio, etc. which helps them maintain and balance between the growth and inflation. Any imbalance in these rates can disintegrate the economy.
Key RBI rates that you need to track are as follows:
Repo Rate – The rate at which RBI lends money to other banks is called the repo rate. A high repo rate, means the cost of borrowing is high, and this leads the economy to grow at a slow pace. Currently, RBI has kept the repo rate unchanged at 4 per cent. RBI increasing the repo rates is not a good news for the banks.
Reverse repo rate – Reverse Repo Rate is the rate at which the RBI borrows funds from the commercial banks in the country. When there is excess liquidity in the market, the banks benefit out of the reverse repo rate by receiving interest for their holdings with the central bank. In return, the RBI offers attractive interest rates to them. However, when banks choose to lend money to the RBI instead of the corporate entity, the banking system’s supply of money reduces. An increase in reverse repo rate is not great for the economy as it tightens the supply of money.
Cash reserve ratio (CRR) – CRR is the amount of funds that all the banks have to mandatorily maintain with RBI. The amount of funds that they maintain is dependent on the CRR. If CRR increases, then the banks need to maintain more funds with the RBI and that much more money is removed from the system, which is not very good for the economy.
Inflation is a multidimensional concept which plays an important role in all the sectors. This is another important factor affecting share prices in the stock market. Inflation basically represents an increase in the prices of commodities and services in any market. Increasing inflation erodes the purchasing power of money and harms the money value. Hence Inflation effects the stock market prices significantly. Inflation is usually measured using certain index values.
1) Wholesale Price Index (WPI)
2) Consumer Price Index (CPI)
These are the two major indices used to analyze and measure Inflation.
Wholesale Price Index (WPI): WPI is used to measure the average change in price in the sale of goods in bulk quantity by the wholesaler. WPI indicates the impact of variation in prices at the wholesale level. This is not a good indicator for prices at the consumer level.
An upward surge in the WPI print indicates inflationary pressure in the economy and vice versa.
Consumer Price Index (CPI): For a consumer, CPI is that matters. Consumer Price Index (CPI) is considered to be a better indicator than WPI as it indicates the impact of change in prices at a consumer level. It is the weighted average of the prices of a select few consumer goods and services.
Calculating CPI is quite detailed as it is one of the crucial metrics for studying the economy. CPI calculation includes classifying consumption into various categories. Each of these categories is made into an index. Thus, the final CPI index is a composition of several internal indices.
A higher CPI could mean inflation and a lower CPI, deflation.
As I write this in June 2021, the Wholesale Price Index Surges at 10.49%.
Index of Industrial Production (IIP)
As the name suggests, the IIP measures the Indian industrial sectors’ production, keeping a fixed reference point. As the production levels and rates vary in various industries, IIP can be a used to determine the increase or decrease in stock market prices. IIP is an index calculated by taking the cumulative value related to the production of 15 select industries. When the indication is of a better production rate, it shows that the economy is in a good phase and if the IIP is low it indicates the bad phase of the economy.
How the economy affects the stock market when the index is low?
Just like the basic economic rule. A fall in the rate of production naturally causes more demand which will shoot the prices up. This will be directly reflected in the stock prices. When the index becomes lower, a slow-moving production environment is created, and this is a negative sign for the economy and markets.
If the IIP is increasing, the production levels are high and this indicates a vigorous industrial environment. Hence, a positive sign for the economy and markets.
Purchasing Managers Index (PMI)
The Purchasing Managers' Index™ (PMI™) is a an economic survey-based indicator. PMI tries to capture business activity across the country’s manufacturing and service sectors.
This measures the business conditions, and its contributing factors like business output, new orders, employment, costs, selling prices, exports, purchasing activity, supplier performance, backlogs of orders and inventories of both inputs and output etc.
A separate survey is conducted for the service and the manufacturing sectors. The data from the survey are consolidated on a single index. Typical areas covered in the survey include new orders, output, business expectations, and employment.
A budget is an annual event, and it is announced during the last week of February. A Budget is an event during which the Ministry of Finance discusses the country’s going forward finance plan in detail. During the budget, major policy announcements and economic reforms are announced, which impacts various industries across the markets. Therefore, the budget plays a vital role in the economy as any tweak in the budget may directly affect the economy and consecutively, the market.
As a demonstration, let’s consider, if the duties on any one commodity were announced to be increased during the budget, say on liquor. And, the finance minister raised the duties on liquor, hence the liquor will prices shoot up. How will it affect the economy?
Increased liquor prices may make the buyers think twice to buy liquor, and hence the profitability of the liquor manufacturing companies may fall. If the profitability decreases, the market of that company gets affected, and then investors may want to sell shares of that manufacturing company.
If market participants start selling, then the markets will come down because ITC is an index heavyweight.
Corporate Earnings Announcement
This is another important events according to which the stocks behave. The listed companies are needed to declare their earning numbers once in every quarter.
This is a major event most investors look forward to. It is the declaration by corporates at the end of every quarter of the year.
During an earnings announcement, the corporates disclose certain details on various operational activities like,
The revenue of the company during the quarter.
The expense of the company during the quarter.
Taxes and interests paid during the quarter.
Profitability during the quarter.
Besides, some companies give an overview of what they expect from the upcoming quarters. This forecast is called ‘corporate guidance’. Such information is highly valuable and it shows the financial status of a company. Investors compare the information with that of the same quarter during the previous year or with that of the previous quarter. If the information reveals that the company’s financial health is on a trail of improvement, it attracts investors and the stock prices immediately go up.
The stock price will react positively if the company’s earnings are better than street expectation. On a similar logic, the stock price will react negatively if the actual numbers are below the street expectation.