6 Mins

US Stocks markets are driven by investor sentiment. A positive or bullish sentiment would take the market up. On the other hand, a negative or bearish sentiment would lead to the falling of the market. Micro and macro-economic factors often drive investor sentiments. They react to company announcements, the company’s financial results, and interest rates and inflation in the economy. This article covers in detail the various factors affecting the US stock market.

Different factors affecting the US Stock Market

Following are the various factors affecting the US Stock Market.

Interest rates

The interest rates or Fed rates majorly impact the stock market in the US. A rate hike would mean borrowing has become costlier, which would eat in the companies’ profits. Lower profit margins lead to a drop in stock prices of companies and ultimately drag the market down. On the other hand, a rate cut would mean money is available for cheaper rates, thus increasing the flow of money in the economy. Moreover, lower costs would increase the companies’ bottom line, leading to a rise in stock prices. Hence resulting in an upward movement of stock markets. However, this is not always true. An inadequate rate cut might not sometimes lead to a fall in the market.

Inflation

Inflation, in simple terms, is a rise in the price of goods and services. In the US, inflation is measured using the Core Consumer Price Index (CPI). Core CPI excludes food and energy-related products. When inflation rises, stock markets fall. Inflation and stock markets have an inverse relationship. Hence a rise in inflation will lead to a fall in the market. However, on the other hand, deflation is also seen as a major economic problem. Inflation at desirable levels is considered good for the market as certain studies suggest that stocks hold real value during inflation. The Federal Reserve uses interest rates to manage inflation in the country.

Inflation reduces the purchasing power of the buyer. However, if managed efficiently, the impact of inflation on a portfolio can be reduced. Investors can use gold to hedge their stock portfolio.

GDP

GDP or Gross Domestic Product is the value of all finished goods and services in the country. An increase in GDP growth indicates the country is growing in terms of production. It gives a positive sign to the investor that the country is progressing and the company is growing. Thus, leading to an increase in the purchase of shares and share price. On the other hand, a fall in the country’s GDP growth would shake the investor’s confidence in the country and the company. Hence, leading to falling in the stock market.

Unemployment

The US government tracks and reports the unemployment rate regularly. The unemployment rate indicates the strength of any economy. Also, the US Bureau of Labor Statistics releases the hiring rate in the country. These two indicators help investors interpret the expected state of the economy and stock market.

Often unemployment is considered as a lagging indicator for the stock market. In other words, by the time the unemployment drops, there would have been some changes to economic conditions. However, there might be an adverse impact on the stock markets when the unemployment rate is higher than expected. A high unemployment rate indicates that individuals are looking for employment but are unable to get one. As a result, the confidence in the economy goes down and impacts the stock market as well.

If the unemployment rate falls and the hiring rates rise, the economic outlook may be positive. Investors expect higher sales, which leads to higher profits for the companies and as a result, the stock prices move up. On the other hand, if the unemployment rate rises and the hiring rate falls, the economic outlook may be negative. As a result, the investor may hold off from investing or even exit their positions.

Trade wars

With trade wars, imports become very expensive due to high taxes, depending on the country of import. For example, the Dow Jones Industrial Average lost more than 300 points when tariffs in China took effect. The index lost further (more than 750 points) due to the tariffs. As a result, it has become expensive for US companies as the import taxes have increased.

During the trade wars, the companies decide whether or not to pass on the excess cost to customers. In other words, for a prolonged war, the companies often pass the additional cost to the customer. As a result, the buying becomes slower, and so the economic growth. If companies do not pass on the costs to the customer, their profit margins shall take a hit. Though trade wars are not long-lasting, they may have a ripple effect on the economy and stock prices.

Industrial output

Industrial output is one of the major indicators of the strength of the US economy. The Federal Reserve, on a monthly basis, releases the Industrial Production Index (IPI), which indicates the monthly outputs in the manufacturing, electric, mining and gas industries. Furthermore, the IPI also provides insights regarding the production levels and capacity utilization (ratio of the output to its capacity).

Industrial output is an important indicator of the economy as it doesn’t consider the price added by the retail sector. The capacity utilization offers insights into the strength and demand in the economy. If any industry shows industrial output lower than the capacity, this may indicate a nearing downturn or a possibility of fiscal stimulus. While, if an industry generates output more than its capacity, it may increase the risk of upward price movements.

Other factors affecting the US stock market

Many other factors may have an impact on the stock market. For example, a company earning many impacts the individual stocks and trends in general. Other man-made or natural disasters too may have an adverse impact on the economy and stock market. For example, COVID 19 has adversely impacted the economy and stock markets around the globe. Also, economic cycles are natural; however, while trying to time the market, one should carefully consider other factors and the market sentiments.

Conclusion

All the economic factors affecting the US Stock Market are interrelated. A rise in GDP would lead to an increase in the supply of goods and services, thus increasing inflation. Also, a cut in interest rates would increase the money supply in the country, leading to more spending and thus rising prices of the goods due to increased demand. Though unemployment will drag the markets down, full employment will increase the demand for goods and services and increase production costs, ultimately leading to a rise in the price of goods or a fall in profits of the company. Hence, increasing or decreasing macroeconomic and microeconomic factors in a controlled way would help stabilize markets in the country.

Investors should be able to leverage various macroeconomic and microeconomic factors to manage their portfolio better. In the light of various factors, they can make investment decisions. However, investing globally can help in diversifying an investor’s portfolio.