Wall Street is a fascinating place. Every single day of the week whole businesses are bought and sold based on years of future earnings, but a single day can send investors into a panic.
You’ve seen articles summarizing a previous trading day. Headlines explain the market’s rise or fall often with a single data point. “Stocks rise 2% as home sales surge!” or “Wall Street ends winning streak on profit taking” are stories you’ve likely seen before. Every move on Wall Street has a cause, at least that’s what the newspapers tell us.
So what really affects the market? Why do stocks rise and fall?
Optimism and Pessimism: How Happy Are You?
What really affects the market is simple: it’s all how investors feel. You’ve heard before that something is only worth what another person is willing to pay. On the market, that is exactly the case. Stocks are only worth what someone is willing to pay. The collective value of all companies on the stock market exceeds the amount of currency that exists to pay for every share.
An excited, overeager investor who sees nothing but unicorns, rainbows, and endless economic growth will give extraordinarily high values to any given company. Bring on bull markets when investors turn optimistic. A pessimistic investor who see nothing but doom and gloom will value everything at zero. Bear markets aren’t very far away.
What really affects the market is the kind of stuff that affects the mood. What makes investors excited and what makes them worried?
Here are some of the things that really move and shake the markets:
- Home sales and housing starts – Investors love home sales data. The American dream is a huge source of wealth creation in the United States as it puts millions of people to work and keeps banks in business. Rising or slowing home sales is a huge factor in confidence because it takes tremendous confidence in the future to make the largest purchase of your life.
- Unrest and conflict – Conflict and unrest in the United States and around the world can have a tremendous impact on stock prices. Civil unrest in Africa can lead to rising oil prices. Protests and strikes in Europe lead to lowered profits and productivity for international companies. These are most important when unexpected. The stock markets around the world tanked on September 11, 2001, for example, as no one knew what to make of the terrorist attacks.
- Elections – We saw this recently with the presidential elections. The US federal Government spends $3.6 trillion per year and writes legislation that affects an economy worth $15 trillion per year. Who’s in charge matters, especially for highly regulated (firearms and tobacco), controversial (oil drillers), or very political (health care) industries.
- Retail sales – The American economy runs on consumption. As much as 70% of GDP is driven by our ability and desire to consume. Retail sales are thus a very strong economic indicator that can point to economic growth or decay as we buy more or less stuff.
- Employment report – The first Friday of every month is the non-farm payroll report, better known as the employment report. Because this is the best way to look at the true health of the economy, it really affects sentiment on Wall Street. Job losses or weak job growth lead to concerned investors and falling stock prices, job gains and job growth lead to rising stock prices.
All of the above can have tremendous short-term impact on stock prices.
Expectations Drive Everything
The mood of investors drives the market and investors are only human – how they feel is “priced in” to the market on each trading day.
Each piece of news or economic data point is only important in so far it is different from what investors expected. For example, if the employment report shows job growth consistent with what investors expected, the market isn’t going to move much in response. Likewise, if retail sales fall as expected, no one is going to dump their portfolio as they already knew what was around the corner.
The most important thing any investor can do is put everything in perspective. While a single economic report might be a big deal for a week of trading, no one is really going to care ten years from now. The green and red of the daily ups and downs are just Wall Street’s mood ring.