FAQs: Factors that impact stock market

1.What are the key factors that influence the stock market? 

While market sentiments can affect the stock market in the short-term as trading activity is driven by short-term money inflows/outflows in the market, over the medium to long-term, economic growth, interest rates, government policy, fiscal deficits, inflation, global growth in the economy and trade has a major impact on the stock market. 

 
2.How does sentiment affect the stock market? 

Any news or information that affects the level of uncertainty for the stock market also affects the market sentiment. For example, when the COVID-19 issue first broke out between late February and mid-March 2020, a high degree of uncertainty drove FIIs to pull out money from the stock market thereby, impacting short-term trading sentiment in the market. 

 
3.How does economic growth affect the stock market? 

There is an imperfect relationship between the stock market and economic growth. The stock market tends to lead economic growth by 6 to 12 months. For example, in FY2021, while the stock market declined by March 2020, the worst of the economic growth was felt six months later in August/September 2020. Similarly, as the markets boomed from October 2020, economic growth as represented by the Index of Industrial Production (IIP) started to turn the corner in March 2021. 

 
4.How do interest rates affect the stock market? 

Interest rates act like gravity on the stock market; the higher they tend to move, the more downward pressure is created on the stock market valuations. As simple interest rates such as the bank fixed deposit rate represent the alternate return option for investors, higher bank interest rates tend to cause outflows from the stock market and into bank fixed deposits. 

 
5.How does government policy affect the stock market? 

The central government may run loose fiscal policy, where it spends aggressively relative to the tax and non-tax revenues it collects. Suppose the government spends more on infrastructure, it will boost economic growth along with the shares of infrastructure companies. Therefore, in the short to medium term, more fiscal spending will boost the stock market. However, in the long-term, higher fiscal spending may cause interest rates in the economy to rise, driving money out of the stock market.  

 
6.How does inflation & global growth affect the stock market? 

Some inflation is beneficial for the stock market as it provides companies listed in the stock market with the ability to increase their revenue by increasing the prices of their products. However, a significant increase in inflation will drive interest rates higher and may cause outflows from the stock market. 

Higher global economic and trade growth will improve the outlook for the stock market as demand for companies' products may be higher due to global demand.