ECONOMIC FACTORS:

Many kinds of factors affect the stock market. Social unrest can cause the market to drop,
while a company discovering a new source of renewable energy can cause stock market
prices to soar. Several economic factors affect the stock market that every investor should
be aware of before getting involved in market investing.
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Inflation And Deflation

Inflation can have an adverse affect on the stock market, according to the article titled
"Forces that Move Stock Prices" as published on the financial website Investopedia.
Inflation is the rate at which the price of goods and services increases. It is the result of
several factors, including a rise in the cost of manufacturing, transporting and selling
goods. When inflation is at a low rate, the stock market responds with a surge in selling.
High inflation causes investors to think that companies may hold back on spending; this
causes an across the board decrease in revenue and the higher cost of goods coupled with
the drop in revenue causes the stock market to drop. Deflation is when the cost of goods
drops. While deflation sounds like it should be welcomed by investors, it actually causes
a drop in the stock market because investors perceive deflation as the result of a weak
economy.

Interest Rates
Interest rates as established by the Federal Reserve Board and individual banks can have
an affect on the stock market, according to an informational pamphlet titled "What Drives
Stock Prices" published by the New York Stock Exchange. Higher interest rates mean
that money becomes more expensive to borrow. To compensate for the higher interest
costs, companies may have to cut back spending or lay off workers. Higher interest rates
also mean that a company's money cannot borrow as much as it used to, and this
has an adverse affect on company earnings. All of this adds up to a drop in the stock
market.
Related Reading: Five Factors or Events that Affect the Stock Market

Foreign Markets
Economic trends in foreign markets can have an effect on the stock market in the United
States, according to the article titled "Riding the Economic Roller Coaster" published in
"Inc." magazine. When the economies in foreign countries are down, American
companies cannot sell as many goods overseas as they used to. This causes a drop in
revenue, and that can show up as a drop in the stock market. Foreign stock exchanges

also have an effect on the American stock market. If foreign exchanges start to fail or
experience sharp drops, then that kind of activity can cause American investors to
anticipate a ripple effect, resulting in a drop in the United States stock exchange.
INTERNATIONAL FACTORS:

World Events
Company stock prices and the stock market in general can be affected by world events
such as war and civil unrest, natural disasters and terrorism. These influences can be
direct and indirect, and they often occur in chain reactions. The social uncertainty and
fear generated by the terrorist attacks on Sept. 11, 2001, affected markets directly as they
caused many investors in the United States to trade less and to focus on stocks and bonds
with less risk. An example of an indirect influence on markets is the announcement of a
new military venture by a country in response to the outbreak of civil unrest or conflict
abroad. This announcement likely would cause the price of the stocks of military
equipment and weapons manufacturers to rise due to an expected increase in defense
contracts, which in turn can raise the value of stocks for companies that supply military
equipment parts and technology. It likely would raise the demand for, and price of,
natural resources used to make these parts, which would raise the price of stocks
representing particular mining and natural resource processing companies.
Related Reading: How to Monitor the Stock Market to Buy Stocks

Exchange Rates
Foreign currency rates have a direct impact on the price and value of stocks in foreign
countries, and changes in exchange rates will increase or decrease the cost of doing
business in a country, which will affect the price of stocks of companies doing business
abroad. While long-term movements in exchange rates are affected by fundamental
market forces of supply and demand and purchase price parity, short-term movements are
driven by news, events and futures trading and are difficult to predict.
POLITICAL FACTORS:

In the top-down approach to investing in stock markets, politics tops the list and its
importance cannot be understated.
It is not surprising that stock markets are nervous with the elections already underway
and crashed by a 213 points as exit polls hinted at a hung Parliament.
Let's take a look at the effects that politics have on the stock markets.
For our study, we have taken the last four general elections held in the years 1991, 1996,
1998 and 1999, i.e. the post-liberalisation phase.
From the table below, we notice that for two of the years i.e. 1991 and 1999, the stocks
markets rallied. Of course, liberalisation in early 1990s and tech mania in early 1999

were also reasons for robust stock markets.

The performance in the other two years has been rather dismal. Interestingly 1991 and
1999 were the two years in which the populace voted in a government (one absolute and
the other a coalition), which had a clear majority to rule the country for the next five
years.
At the same time, in the other two years, political instability was a reality.
January

December

Change (%)

GDP Growth (%)

1991

982

1,909

94.4

5.6

1996

3,049

3,085

1.2

7.3

1998

3,720

2,963

-20.3

4.8

1999

3,060

5,006

63.6

6.6

The reader may be tempted to conclude that during years when the populace voted for
stable governments at the Centre, the stock markets rallied. A stable government is not
the beginning and the end of it.
Despite strong economic growth in the last few years of the Congress tenure between
1995-96, the party was voted out of power in 1996. For the next two years, the country
was plagued by political uncertainty and the economic condition was also mixed.
While the real GDP growth in FY97 was over 8%, one of the highest ever in the history
of the country, it fell to 4.3% in the succeeding year.

It can, to a certain extent, be observed that political uncertainty has a bigger impact on the
stock markets than the performance of the economy. This is because, for any economy to
grow and prosper, it needs to implement policies and reform measures that may bring
fruit only over the long term.
So, while the stock market participants may factor in the benefits of a stable government
very early, it will take some time to reflect on broader economic parameters like per
capita income, interest rates, inflation and so on.
In the Indian scenario, years of rule under the Congress government led to a state where
the country relied largely on PSUs (public sector undertakings) for employment
generation.
The License Raj also stunted the incentive to invest as far as the private sector is
concerned.
In 1991, when the economy was liberalised, it was more so out of compulsion than out of
choice. In the Indian context, while the economic liberalisation was gradual, results

started to show in the latter years of the Congress rule of 1991-96.

The stock markets rewarded this performance in the period between 1991 and 1996 by
way of a huge 210% rise in the Sensex levels. This directly corroborates the argument
that a stable government at the Centre is of significance for the stock markets.
Without taking political sides, we observe similar performance in the stock market in the
period since 1999 and now. Even if one were to discount the 2000 stock market rally,
which may have been an anomaly, on a point-to-point basis (1999-04), the Sensex gained
94 per cent.
As is evident, during period of a stable government rule (early 1990s and in the last five
years), more number of steps seems to have been taken as far as economic policies are
concerned.
Yes, there may have been odd hiccups. But overall, the direction of government policies
has been clear when there is stability. Be it, simplifying tax structures (direct and
indirect), foreign direct investment policies, strengthening the financial system,
government spending and reforms in public infrastructure and utilities.
All these have shaped the way India has emerged over the last fourteen years. While we
are not getting into the argument of who did the best, generally, the decision-making has
been faster when there is independency in framing of policy (the classic case is the
functioning of the Reserve Bank of India) and stability at the Centre.
All these reforms carried out over the period of the last 14 years have managed to make
India Inc. more competitive in the global scenario.
The investing community, recognizing this improvement and potential of Indian
companies, has shown its confidence in the stock market. Having said that, we still have a
long way to go.
So, what is the lesson? Investors at this stage need to realise that a stable political
situation at the Centre is always beneficial for them. Since economics touches the life of
each one of us in one way or the other, it becomes important that the electorate makes an
informed decision as to who should be voted to power.
The election manifestos of various parties play an important role here. While the
promises may not always be met, one needs to exercise higher weightage to the overall
direction of a party and the people who are likely to make decisions on 'your' behalf.
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