Possibly the biggest indicator of the health of an economy is consumer activity and spending. Generally, this is because if no one is spending money, then no one is making money. So, naturally consumer confidence has the potential to influence the share market in a big way. When consumer confidence is high, typically investors will be more optimistic of the share market and the companies listed, but when consumer confidence is low, it has an adverse effect.
Furthermore, the rate of employment often impacts consumer spending. When unemployment is high then typically consumer spending drops and this in turn will likely impact the earning potential of certain companies. However, at times of high unemployment there are some stocks that tend to perform well, such as consumer staples (such as food, drugs and basic household goods) and blue chip stocks that tend to be less volatile.
Related article: What is a Yield Curve and why does it matter?
Effectively, interest rates represent the cost to borrow money. So, when interest rates rise, there is less money in circulation stimulating the economy and driving consumer spending. In time, this can affect the share market. However when interest rates are down, often the share market will get a boost as investors flock towards equities in order to get a higher return than what is offered in the bond or cash market. For more on this, check out this article.
At the time of writing the official cash rate is sitting on 0.75%, which is historically low.
Rising inflation is another economic indicator that generally affects the share market. As inflation rises, the cost to produce goods and services increases also. This reduces consumer purchasing power and can negatively affect a company’s profits and consequently their stock price. On a larger scale, high inflation can slow down the economy. The Reserve Bank of Australia (RBA) will continuously monitor the level of inflation for this reason.
The RBA’s target band for inflation is 2-3% and at the time of writing inflation is sitting at 1.6%.
Given that we live in an increasingly globalised world, often when investing locally, like on the ASX, the chances are you are still exposed to international markets and economies as companies expand worldwide. This is particularly true of companies that export their goods overseas. This is where exchange rates come in.
An exchange rate is the value of one currency when exchanged for another. If the Aussie dollar is weak against other currencies this suggests the Australian goods will be cheaper overseas and this may increase sales. For the short term, a weaker dollar can mean the stock market will show price rises across the board.
Related articles: What is the Big Mac Index?
Nothing is for sure
Getting you head around some of the key economic drivers that impact the share market can help investors make more informed trading decisions. But bear in mind, no one can predict the future and the share market may not always react as expected. Therefore, nothing is guaranteed and it’s always best to do your research before investing and consider your own personal circumstances and goals.
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