Although the stock market is incredibly difficult, if not impossible to predict, seeking to understand its fluctuations may help one limit uncertainty.
Xiaohan Ma, an assistant professor in the department of economics, said that from an economic perspective, the stock market is viewed in the same way as any other aggregate market.
“So, from the economic perspective, the stock market is like all the other markets in the economy,” he said. “So, if you look at, for example, the GDP (Gross Domestic Product), the aggregate product itself, so it has cycles. I mean, the long-run trend is increasing, but occasionally there may be fluctuations around the trend so that, you know, sometimes there is up, sometimes there is down.”
It may be impossible to pinpoint the causes of these fluctuations, but Ma said some factors, called fundamentals, influence what happens in the market.
“So, generally speaking, like in economics, you really think that there may be something called fundamentals, so economic fundamentals, that are the driving force of those ups and downs,” he said.
The stock market may be an indicator of how well the economy of a country is doing, Ma said.
“So, nowadays, like the financial market itself, you can think of that as a fundamental for the overall economic growth,” Ma said. “So, the recent — the Great Recession was just due to some disturbance in the financial market, in the housing market, so the real GDP in the end declined, the economy experienced a recession; but then for the stock market, the fundamental of that is, some say, is like the future profitability of firms.”
Ma said when the general public expects a firm to do well, the firm’s stock price tends to increase, corresponding with an increase in the stock market overall. If people expect a stock to fall, it tends to fall because people refuse to invest in a stock with little odds of profitability.
Some people, Ma said, may believe the stock market repeats itself over time.
“So, now I think people may believe that the current situation is like last year, so before the market crashed — or I would say, before the index declined,” Ma said. “So, the situation is similar, so people might think that, you know, history will repeat, so we might have another kind of decline.”
various reasons, some of which may be unknown. Ma said two of these reasons include firms becoming profitable and increased optimism in the market or profitability.
“So, you know, when people are over-optimistic about the market,” he said, “then they may believe that if they invest now, they will earn more in the future, but by investing in the stock market, then when a lot of people go to the market, it’s like the demand for the stock will increase. So, as a result, the price will increase — that is the index.”
If firm profitability is the cause of a market increase, Ma said he would expect the stock market would not decline in the near future. It is when people are overly optimistic in the market that a “bubble” may form.
“Then, when the bubble breaks, you know, it means the stock market actually will decline,” he said.
Aside from local influences, Ma said foreign happenings such as the Coronavirus and fear of the virus may also influence the global market, which in turn may likely impact the market in the United States.
“But the stock market, you know, is affected by the level of risk,” he said. “So, if people believe that there is a higher level of risk due to that virus, then it may have a bigger impact on the stock market compared to other financial markets.”
Risk and expectation play a role in stock market fluctuations. Assistant professor from the department of economics Julian Ludwig said the mood, or animal spirit, of people explains how likely one is to invest.
“So, when animal spirit is low, that means nobody wants to invest anymore,” Ludwig said. “There might be investment opportunities, but nobody is in the mood to invest, and therefore firms shrink, the economy shrinks, people lost their jobs and so on.”
The spirit animal term was coined by British economist John Maynard Keynes to describe the psychological aspects of one’s decision to either invest or not invest in the market when uncertain, according to the Investopedia website.
To encourage economic growth when the animal spirit of people is low, Ludwig said the government may intervene.
“For example, the Federal Reserve lowers the interest rate which makes saving money less attractive,” he said, “so if the interest rate is low, then you get very little money from your bank account, so you don’t want to put your money in the bank account anymore; you want to put it into the economy, and then you start buying businesses, you start consuming more, investing more and so on, and then that should help get the animal spirit up again.”
The animal spirit may fluctuate for a few reasons, one of which Ludwig said is simply random mood changes.
“The other theory is that people anticipate future growth,” he said, “so people are in a good mood for a reason because they know that new technology is going to come up or investing now is particularly attractive because they have some information about the future — that the future is good.”