THE INTERLINK BETWEEN MACROECONOMIC ELEMENTS AND THE CAPITAL MARKET
The Relationship Between Macroeconomic Elements and The Capital Market
Summary
Capital markets across the world are characterized by expected and unexpected changes; all of which are attributed to numerous variables. As such, it is important to highlight that forces emanating from the macroeconomic sphere are among the primary contributors of such changes in the stock markets. Variation of different macroeconomic factors such as GDP and the supply of money have different effects on the volatility of the capital markets. This paper will offer an objective examination of the link between those variables and the local and global stock markets. The paper will be based on factual arguments drawn from previous studies on the topic. There exists a direct relationship between the macroeconomic factors and the capital markets; such that, any change in a single or several such variables triggers corresponding variation of different aspects of the stock markets such as stock prices and volatility.
Background
Capital markets are influenced by different factors; all of which result in different events in the market. As such, the aim of this paper is to offer an objective evaluation of the different effects of specific elements of the macro economy. They include banking, the financial sector, and overall macro economy. It will dig into different research materials to ascertain the extent to which the stock markets respond to variations in these factors. As it will be established, the different factors result in different effects on the capital markets.
Research Questions
- What kind and extent or relationship exists between the global stock market and the banking sector?
- Does the stock market have a significant correlation with IPI?
- What is the possible correlation between stock market and CPI?
- What is the correlation between the global stock market and different macroeconomic elements?
- What are the most identifiable links between the global stock market and levels of investment and risk?
- What actions can policymakers and decision makers take to ensure stability in the global stock market?
- What are the indicators of adverse or favorable trends in the global stock market?
Study Objectives
The primary objectives included in this study are:
- To ascertain if there exists a verifiable link between events in the banking sector and the overall performance pf the world’s capital market.
- To identify whether a considerable relationship exists between stock market performance and IPI.
- To investigate whether a correlation exists between stock market performance and CPI.
- To establish the nature of relationship that exists between overall stock market performance and macroeconomic elements in the world.
- To highlight the nature of correlation that is justifiable between the world’s capital market performance and levels of investment and risk.
- To highlight any recommendable actions can policymakers and decision makers take to ensure stability in the global stock market.
- To identify the indicators of adverse or favorable trends in the global stock markets.
Literature Review
Different studies have established that capital markets are significantly affected by majority of factors, including changes in the supply of money, economic growth, fiscal deficit, GDP, current account balance, CPI, and industrial production index among others (Osamwonyi and Evbayiro-Osagie, 2017, p.57). The author posited that favorable changes in the IPI and CPI in the economy trigger positive changes in the stock market while adverse changes trigger negative changes. The two variables are directly related to the evident trends in the stock market across the globe. The scenario is cemented by the Vector Error Correction Model, favorable variations in different economic variables trigger favorable changes in the capital market performance metrics. There is a direct relationship between these factors and capital markets, and it is recommended for countries to adopt appropriate economic variables in a bid to achieve the desired levels of growth and stability in their respective stock markets (Bahloul, Mroua and Naifar, 2017, p.64). The positive correlation between macroeconomic indicators and stock exchange index is consistent with existing literature. It is also worth noting that global economic variables are more influential to the stock markets compared to domestic ones. However, flawed or weak domestic macroeconomic variables could be transmitted to the global stock marketplace.
The study by Li (2012) affirms that the supply of money in an economy is strongly correlated to the price of stocks traded. High money supply in an economy implies that people have high ability to make sizeable purchases. As such, the demand for stocks in the capital markets will rise, causing an offsetting effect in the price of such stocks. The prices of stocks rise in times of high money supply. On the other hand, policies aimed at reducing the level of money supply in the economy reduce the demand for stocks because people have reduced ability to purchase (Li, 2012). Therefore, the relationship between the supply of money and stock market reinforces the premise of the Vector Error Correction Model. Favorable changes in the supply of money trigger favorable changes in the price and stability of stocks while the contrary results in adverse effects. The traditional theory holds that increased money supply could result in improvement of safe assets ratio. This implies that the public is equipped with sufficient financial ability to acquire capital investments in the market with the aim of earning high returns. The situation increases the demand for such assets; thus, leading to increased prices (Li, 2012). It results in a scenario whereby the replacement costs of firms within the market are less than their actual values; thus, attracting higher levels of investment in stocks. The resultant effect of such situation is increased value of stocks as well as diminished stock volatility. Overall, money supply is positively correlated to the demand, price, and stability of stocks in the economy.
Further, Hoque & Yakob (2017) established that the level and rate of economic growth is a primary determinant of the prices of stocks as well as the stability and returns earned on stock investments. Drawing from the common theory, economic growth is associated with increasing returns on investment as well as decreased stock volatility (Hoque & Yakob, 2017). In times of economic growth and stability, the discounted expected earnings of stocks increase proportionally. Economic growth stimulates market growth (capitalization) as well as increased liquidity in the economy. The volatility of stocks also declines during times of economic growth because the investors become less worried about losing their investments. Therefore, the development of the stock market is directly related to the nexus of economic growth as evidenced by the Granger causality test which confirms the existence of unidirectional impacts on the stock market (Hoque & Yakob, 2017). The positive correlation between economic growth and stock market development is further justified by the Gregory Hansen cointegration test. Portfolio investments are positively impacted by the level of economic growth as well as GDP levels in an economy. Such economic stability results positive returns in the capital markets; thus, cementing the argument for strong positive correlation between economic growth and capital market returns.
The direct influence of macroeconomic variables on the stock markets, was also studied by Demir (2019, p.8), and established that it could be attributed to numerous reasons such as the effects on stock prices due to the influences on future cash flows as well as the discounting rates for such cash flows (Demir, 2019, p.8). Comparatively, fluctuations in macroeconomic variables have significant influence on the returns expected to be derived from the stock markets over time (Pal and Garg, 2019, p.4). For instance, a rise in inflation in a country or across the world results in declining purchasing power of the currency used in the affected markets. The decline in purchasing power of the currency, say dollar, implies that each unit can purchase fewer goods and services. The outright result of inflation in a country results in declining prices of stock. It is also important to highlight that the expectation for inflationary tendencies can also result in positive or negative effects on stock prices and returns. The impact is greatly determined by the investors’ hedging abilities as well as the prevailing monetary policy. Overall, stock prices and returns are strongly and positively correlated to the level of inflation; especially in times of economic contractions. Kwofie & Ansah, (2018) also established that inflation also influences the level of growth and performance of stocks. They posited that inflationary tendencies in an economy slow down the growth of stocks by crippling the banking and financial sectors. Imperatively, there exists a positive correlation between the return on stocks and inflation for value stocks while growth stocks are negatively correlated to the same. Therefore, inflation increases the level of uncertainty associated with investment in value stocks; thus, causing a corresponding decline in the returns and slowed growth. The effects of inflation on the stock market are dynamic because they affect the present and future prices, returns, and volatility of the stocks in the entire market. Inflation affects the future value, returns, and price of stocks due to the principle of speculation as investors seek to earn the highest levels of yield from their investments (Kwofie & Ansah, 2018). The bidirectional relationship between the stock returns and inflation is in line with Fisher’s hypothesis; therefore, stock prices rise during constantly rising inflation and decrease at low levels of inflation.
The link between gains earned from stock investment and the economic factors is also unidirectional because; for instance, variations in the prevailing stock indices have direct effects on the interest rates. The condition cements the argument that there is a strong, direct, and unidirectional relationship between the factors and the capital market (Aggarwal & Saqib, 2017, p.11). The variation of interest rates is mainly centered on the banking and financial sectors. The situation is not specific to any country but applicable to both global and national stock markets. An increase in the interest rates within any economy will make borrowing a more costly affair; thus, pushing bond prices higher. The situation causes the price of stocks to decline due to reduced ability of people to purchase them as a result of low purchasing power (Chen, 2017). Low interest rates, on the other hand, encourage people to borrow more money and make huge purchases. As a result, it could trigger high demand for stocks; thus, pushing their prices up. Therefore, interest rates and stock prices exhibit a strong negative correlation.
Other factors such as current account balance, productivity index, and fiscal deficit have also been highlighted as influential to the stability and development of stock markets. For instance, high levels of fiscal deficit trigger adverse effects on the prices and stability of stocks in the capital markets. According to Joshi & Giri (2015), a budget deficit in any economy results in adverse effects on the prices and stability of stocks within the country. The negative correlation between stock markets and budget deficit is centered on the unattractive nature of the economy’s capital markets; a feat that reduces the market demand for the affected assets (Joshi & Giri, 2015). The negative correlation between the two aspects tends to persist in the long run. On the other hand, fiscal deficit in an economy would trigger price decrease for the stocks in the short run. As such, governments should formulate and implement robust macroeconomic policies in a bid to militate against any instances of budget and fiscal deficits for the development and stability of their stock markets.
Research has also established that changes in the global banking and financial sectors are major influencers of the global stock markets. The argument is based on the fact that the two sectors are primary sources of finances used to acquire assets in the capital markets (Osamwonyi and Evbayiro-Osagie, 2017, p.57). As such, the two sectors are critical determinants of the supply of money in the economy; thus, driving the level of demand for capital assets across the globe. Strict borrowing legislation or increased interest rates could constrain the ability of individuals to access money for purchasing capital assets. The levels of investment and risk also determine the motivation of individuals to acquire stocks because they have a direct impact on the attractiveness of the assets to be acquired.
Methodology
Research Design
The preferred research design for the study will entail the utilization of multiples method and pay practices analysis. It will, therefore, deploy a grounded interpretative approach for the examination of the global experiences of organizations’ top management in relation to the stock market. The goals will be achieved using events in the global markets and the deployment of the available secondary research. An interpretative method will be appropriate for this study since it allows examination of the pay system according to the existing theory to develop empirical data.
Sample and Sampling Method
The data will be obtained from previous research studies through random sampling. The process will be obtained from research literature, government reports, and other academic scripts. The sampling process will involve checking and analyzing the records against the random inclusion and exclusion criteria.
Data Collection
The data will be obtained from journals, e-books, and government records. Secondary data will be chosen since much of the shared information about macroeconomic elements and stock market is readily available in the public domain. The researcher will therefore conduct complex statistical analyses to accomplish the five objectives of this study.
Data Analysis
The collected information will require objective scrutiny in a bid to ensure that it gives appropriate answers to the highlighted questions in the paper. As such, it will be analyzed using different approaches, including SPSS. The approach enables the critical analysis of data such that researchers can establish specific trends of patterns and present the same in clear graphics. ANOVA and regression methods will also be applied for detecting any variations among the respondents. It will also be compared with previous research information to establish any similarities and differences. Specifically, coding will be used to identify common themes from the data that will help to meet the research objectives (Guetterman, Fetters & Creswell, 2015). Coding will be aimed at developing and highlighting sensibility of the data collected. The process will start by extracting preliminary codes from the data followed by filtration and refining to gain more precise and accurate data.
Schedule
| TASK | Sep- Dec 2019 | Jan-March
2020 |
April-June 2020 | July-August
2020 |
Sep-Nov.
2020 |
Dec 2020-Feb 2022 | March 2022 | March
2022 |
| Literature Review | ||||||||
| Proposal writing and presentation | ||||||||
| Preparing for data collection sheets | ||||||||
| Content Analysis: Secondary data collection | ||||||||
| Data analysis (Primary and secondary data) | ||||||||
| Consultation with the Supervisor | ||||||||
| Thesis write up | ||||||||
| Defense of thesis | ||||||||
| Feedback to respondents
Vote of thanks |
References
Aggarwal, P. and Saqib, N., 2017. Impact of macro-economic variables of India and USA on Indian stock market. International Journal of Economics and Financial Issues, 7(4), 10-14.
Bahloul, S., Mroua, M. and Naifar, N., 2017. The impact of macroeconomic and conventional stock market variables on Islamic index returns under regime switching. Borsa Istanbul Review, 17(1), pp.62-74.
Chen, H., 2017. Research on the Relationship between Interest Rate and Stock Price in China. International Journal of Science and Research (IJSR), 6(7), 2093-2099. doi: 10.21275/27071710
Demir, C., 2019. Macroeconomic determinants of stock market fluctuations: the case of BIST-100. Economies, 7(1), p.8.
Guetterman, T. C., Fetters, M. D., & Creswell, J. W., 2015. Integrating quantitative and qualitative results in health science mixed methods research through joint displays. The Annals of Family Medicine, 13(6), 554-561.
Hoque, M., & Yakob, N., 2017. Revisiting stock market development and economic growth nexus: The moderating role of foreign capital inflows and exchange rates. Cogent Economics & Finance, 5(1). doi: 10.1080/23322039.2017.1329975
Joshi, P., & Giri, A., 2015. Fiscal deficits and stock prices in India: empirical Evidence. International Journal of Financial Studies, 3(3), 393-410. doi: 10.3390/ijfs3030393
Kwofie, C. and Ansah, R., 2018. A Study of the effect of inflation and exchange rate on stock market returns in Ghana. International Journal of Mathematics and Mathematical Sciences, 2018, 1-8. doi: 10.1155/2018/7016792
Li, Y., 2012. Empirical Study on the relationship between money supply and stock market in Europe. Information Computing and Applications, pp. 539-544. doi: 10.1007/978-3-642-34062-8_70
Osamwonyi, I. and Evbayiro-Osagie, E., 2017. The Relationship between macroeconomic variables and stock market index in Nigeria. Journal of Economics, 3(1), pp.55-63.
Pal, S. and Garg, A., 2019. Macroeconomic surprises and stock market responses—A study on Indian stock market. Cogent Economics & Finance, 7(1), pp.1-10.
