Why do share prices fluctuate?
- Financial Planning
Wouldn't it be great if there was a simple way to forecast how share prices would move? The reality is that share market fluctuations are notoriously hard to predict. This isn’t really surprising when you consider the complex range of factors that influence share price movements. Some of these factors have quite an obvious and logical effect, but others can seem irrational and unpredictable.
Investment managers invest a considerable amount of time and money in researching and assessing how shares and markets will perform, but even with all these resources there are no guarantees of getting it right.
Here is a quick summary to help you get a grasp of the dynamics involved.
Company performance indicators
At the most fundamental level, how a business performs affects its share price. The indicators of that performance primarily take the form of financial measurements, such as profit, revenue reports or dividend payments. There may also be other developments such as employee layoffs, mergers, management changes and product launches, which can affect the market's perception of the business and therefore affect the share price.
Industry sector developments
At a broader level, the fortunes of the industry sector in which a business operates may influence its share price. For example, a downturn in market demand for a particular type of product may affect the share price of businesses within that industry sector. There may also be times when a business within a sector loses a customer or makes a poor decision, results in other businesses within that sector benefiting from a perceived competitive advantage. This may affect the share price of these businesses.
Market demand for a particular type of product may affect the share price of businesses for certain industry sectors
Of course hard facts and figures are not the only force at play when it comes to the ups and downs of share prices. Emotion plays a major role too. Investors may be spooked by a particular piece of news and may overreact to that news and cause a share price of a particular business to drop. While this may not be a rational reaction, it certainly plays a major part in the direction of the overall market. Investors can sometimes act with a “herd mentality” when they lose confidence and this can fuel a downturn.
Dynamics within the economy may also have an impact on shares. As an example, the Reserve Bank may adjust interest rates as a means of either stimulating or dampening the growth of the economy. An increase in rates can sometimes have a negative impact on share prices because it makes it more expensive for businesses to borrow money and this can limit profits and dividends. Higher interest rates may also lead to greater demand for fixed interest investments, such as government bonds, resulting in a downturn in demand for shares.
The general economic outlook and the confidence of consumers and investors can also influence share price performance. If an economy is expanding, share prices may benefit from the positive mood and expectation that businesses will be selling more of their products and services and investing more in their business. Conversely, if confidence is low and the economy is contracting it may reduce demand for shares and push prices down.
A change of government can sometimes create negative or positive perceptions about whether policies will help or hinder business conditions and this in turn can affect share prices.
Inflation can have a limiting effect on consumer demand and make it harder for businesses to make profits, which may flow through to share prices. Inflation may also prompt the central bank to increase interest rates, which can further dampen demand. If demand is strong enough within a particular sector, however, inflation may not affect sales and the higher prices may lead to an improvement in business performance and its share price.
The exchange rate of the currency may affect share prices, particularly for exporting businesses. The lower a currency falls, the greater demand this may create from overseas customers and a positive flow-through to share prices may result. The opposite may happen if the value of the currency is increasing.
Disasters and turmoil
From time-to-time sudden events such as natural disasters, wars and political upheavals can have an impact on markets and share prices. Markets can sometimes react quickly to such events and send prices down, although these exaggerated reactions can sometimes be quickly reversed just as dramatically once positive news filters through.
Making sense of it all
The many factors that influence share prices underscores the importance of receiving sound, broad-based advice when it comes to making decisions for your own investment portfolio. A financial planner can give you access to expert research resources that can help you make well-informed decisions that lead to long term success. A long-term approach to share market investing prevents knee-jerk reactions to the inevitable twists and turns that share markets take.
What are your thoughts on the factors affecting share prices? Share your opinions below.