Factors That Move The Indices

Indices by definition are generally indicators which are used to measure the performance of certain sectors of the economy. The construct and constituents of these indices depends on the key performance indexes which are needed to be measured or monitored. For example, to measure  inflationary pressure in the economy, the consumer price index (CPI ) is usually taken as the barometer of inflation. The constituents of the CPI normally comprises of the prices of a basket of everyday essential goods of a typical household. Stock market indices are local indicators comprised of a basket of various companies eg. the FTSE 100 is made up from the top 100 listed on the London  stock exchange.

With the financial markets, they have been experiencing rapid growth during the last few decades. As such, these market indices are also gaining in importance not just as barometers of the economy but also as vehicles of investment as well. On average, the returns for stock markets indices during the last 10 years was 77% with the Mexican IPC index returning a whopping 535%! Hence, it is not surprising that investors would want to know what the factors that influence market indices.

It should be noted that factors affecting indices depends on the index in question as they are made up of different components. Because each component of an index have different internal and external factors that can affect it, it is not possible to  list all of these factors. Instead, we need to look at the fundamental factors behind the movements of these market indices.

Fundamental Factors

Fundamental factors in the analysis of indices are factors are those factors which can be reasonably ascertained and include profit and loss of a constituent company, the interest rate. inflation, the tax rate and prices of inputs such as raw materials, labour and oil.

As company profits affect the price of a company’s share, this will ultimately affect a market index if that company’s share is included as a component of that index. Hence, all the above mentioned factors are factors contribute directly to the company’s bottom line. Profitable companies are more likely to declare dividends. As a result, more people are willing to invest in that company’s shares pushing its price up and with a similar effect on the index which the company share is a component of.

On the other hand, if a company is in the red, this will result in less investment in the company’s share. The end result will be a fall in the share’s prices and subsequently in the index as well if the fall in share’s prices is significant enough.

We should also bear in mind that in a globalized economy, a company’s share can also be affected by external factors which has nothing to do with the inner workings of the company. Companies which are more susceptible to external factors are normally companies which are export orientated. For example, a high exchange rate might be desirable for importing firms but are generally bad news for exporting firms as it makes their products more expensive on the international market. With less sales, this mean less profits and less investment in these companies’ shares.

Geopolitical factors can also have an effect on how indices move. A recent example of this is the effect of North Korea sabre rattling and reports of bird flu deaths in China on the Stock Exchange of Thailand (SET) index. The SET fell by as much as 2.55% as a result of panic selling. Concerns about the state of the U.S economy had also a fall in indices across most of the other Asian markets recently.

As we have seen, traders who want to have an edge in trading indices must possess the ability to dissect news on both a micro and macro level. Because there are so many factors involved, it is not enough to analyze a piece of news in isolation without considering the bigger picture.

Currencies can also move indices for instance if the YEN is weaker then the price of goods in Japan will go down, this will affect the amount of exports from the domestic companies. The better the company performs, the higher their stock value can be and so with enough well performing stocks in Japans Nikkei 225 for instance the higher this index moves.