An Investor’s Guide to Market Drivers

There are myriad theories explaining what drives equity markets. Trying to wade through them all could prove bewildering. Yet, in our view, it is important for investors to identify which factors do—and typically don’t—drive markets meaningfully. Here we cut through the clutter to help you understand why we think markets move as they do.

In our view, equity prices, like most prices in a market economy, are driven by supply and demand trends. Supply is the total number of publicly traded companies’ shares outstanding—which ordinarily doesn’t change much in the near term. Share supply increases primarily through companies selling shares to the public, either for the first time in an initial public offering (IPO, often called going public) or a secondary offering. Companies do this generally to raise capital for some form of later use—cashing out early investors, acquiring a competitor or using the funds to reinvest into growing the business. Share supply can decrease via a number of means, including companies repurchasing shares listed on the market, cash-based mergers and acquisitions or bankruptcies.

Sometimes supply matters—in our view, the classic example is the dot-com bubble, when it surged. In the late 1990s, many companies, that our analysis showed lacked viable long-term business prospects, rushed to go public. The flood of low-quality shares expanded supply dramatically—a contributor, we think, to the 2000–2003 bear market (a fundamentally driven decline exceeding -20%). It is fairly rare, however, to see supply tilt heavily towards rising or falling in the short term. Many of these activities, like going public or buying back significant amounts of equity, take time. They also often occur concurrently, partly offsetting one another. Hence, in the near term, we think demand swings markets most.

Most popular

Steerpike

Reform tops poll for first time

Demand drivers fit three broad categories, in our view: economics, politics and sentiment. Economics’ influence is fairly straightforward. Investors, in our experience, usually buy shares for their future earnings potential, which often depends on the economic outlook. If investors expect economic expansion ahead, they may anticipate rising sales and earnings. That could increase their willingness and desire to own shares, stoking demand. If conditions look murky or contraction seems likely, demand may fall.

Politics can influence the business cycle, affecting demand. We don’t think this has much to do with traditional notions of one party or set of politicians being pro-business and others anti-business. In our review of market history, we have found markets favour no party consistently. We think what matters most here is how policy actions can create uncertainty around property rights. If sweeping enough, businesses might forestall investment, cutting short economic expansion. Legislation and policy can also affect the rules of doing business—creating winners and losers in the process.

Last, but not least, sentiment refers to the general mood amongst market participants. Are they pessimistic about economic and political developments, euphoric, or somewhere in between? We think how this sentiment aligns with reality is a critical determinant of demand and markets’ longer-term direction. If reality turns out better than expectations, markets tend to rise, as positive surprise stokes demand. If worse than expected, disappointment may rein in demand. Inflection points—when sustained periods of rising prices, called bull markets, begin or end—are often characterised by extreme sentiment: euphoria as markets crest, dire pessimism at their nadir. There are many tools to help gauge sentiment, including investor surveys, consumer-confidence surveys and more. But this is more an art than a science, in our view, and must incorporate qualitative assessments of media and professional-investor opinions.

With equity markets’ supply and demand drivers in mind, we think it is just as important to know what doesn’t drive markets. One major item we see many investors get caught up in: past news and data. Most economic data report on backward-looking events—what happened in the last month or quarter. The problem with this is, markets look forward around 3–30 months, in our experience. We think markets already anticipated—and digested—most of what subsequent economic reports hint at. In a similar vein, markets’ past prices don’t influence the future, in our view. Hence, studying recent movements on a chart to predict future moves—as many investors do, in our experience—isn’t likely to prove helpful. Charts can describe what happened usefully, but we don’t think they predict.

Then again, we think events occurring beyond about 30 months also generally fall outside the scope of things impacting markets. In our view, this is because the further into the future you go, the more variables there are to account for, making it harder to assign probabilities to specific outcomes. Consider, for example, long-range projections of sovereign budget deficits. To be accurate, these would need to pinpoint a lot of unknowable factors: population growth, immigration, how many (and when) recessions strike. After all, COVID-19 is having a huge budget impact across most of the developed world. Yet very few anticipated anything like this at 2019’s close—much less 10, 20 or 30 years earlier.

So remember, when assessing a development or news story, ask yourself: How will this affect future demand for equities? The answer may help guide your actions.

Interested in other topics by Fisher Investments UK? Get our ongoing insights, starting with your free copy of The Definitive Guide to Retirement Income.

Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.