What are Macroeconomic Factors?
A macroeconomic factor is an influential fiscal, natural, or geopolitical event that broadly affects a
regional or national economy (Bloomenthal, 2022). Some well-known macroeconomic factors are the
unemployment rate, GDP, inflation and interest rate. I will explain the significance of these factors
later on in this document, and will try to describe their impact on the stock market in the best way
possible.
Before going any further, let me clarify that macroeconomic factors cannot really be predicted, and
mainly only assumptions can be made. Charlie Munger, a lawyer and business partner of Warren Buffett, gave the following quote in an interview:
“Microeconomics is what we do, Macroeconomics is what we put up with”
By this he means that, as investors, they focus entirely on the companies themselves, the
microeconomy level, and care little to nothing about the macroeconomy due to it being beyond their
control. It is important to keep this in mind.
Meaning and interpretation of the following macroeconomic factors:
Interest rate
Central banks adjust interest rates relative to the health of the economy. But what does this mean?
The interest rate is what normal banks pay central banks when borrowing money. When interest
rates rise it becomes more expensive for banks to borrow money, this then gets passed on to the
consumers making it more expensive for them to borrow money as well.
When the economy is difficult times, for example during the COVID-19 pandemic and the 2008
financial crisis, central banks tend to lower interest rates to make borrowing money cheaper and
thus helping companies stay afloat.
Now, in early 2023, with skyrocketing inflation, the opposite is true. Central banks have raised
interest rates, making it less attractive for companies to borrow money and invest in their growth.
Why are they doing this? By raising interest rates, the central banks indirectly decrease consumption,
this leads to less spending by businesses and consumers, thus lowering the inflation.
The chart below shows the interest rates of America’s central bank over the past 10 years (FED).
What consequences do changing interest rates have on the stock market?
It has a temporary negative effect on the stock market. The economy slows down due to decreased
investing/ spending by businesses and consumers. As a result, stock prices fall, with the occasional
exception of financial companies.
When interest rates return to normal, investors feel optimistic about the stock market as businesses
will resume investing in their growth and consumers will increase their spending and borrowing of
money.
Inflation
Inflation is the rate at which the general level of prices for goods and services rises, and
subsequently, purchasing power decreases. Central banks attempt to limit inflation, and avoid
deflation, in order to keep the economy running smoothly.
Inflation is typically measured by the Consumer Price Index (CPI), which tracks the prices of a basket
of goods and services that a typical consumer might purchase. The rate of inflation is determined by
the percentage change in the CPI over a certain period of time, usually a year.
There are different types of inflation, such as demand-pull inflation and cost-push inflation. Demand-
pull inflation occurs when there is more demand for goods and services than the economy can supply, leading to an increase in prices. An example of this might be a strong economy leading to
more consumer spending, which in turn drives up prices.
Cost-push inflation, on the other hand, occurs when the cost of production increases, leading to
higher prices for goods and services. An example of this might be an increase in the price of oil, which
would lead to higher transportation costs and therefore higher prices for goods that need to be
transported.
Another type of inflation is called built-in inflation, it occurs when businesses expect prices to rise in
the future and they start raising their prices today to keep pace with this expected inflation. This can
become a self-fulfilling prophecy, as the expectation of higher prices causes prices to actually rise.
Central banks try to control inflation by using monetary policy, which involves adjusting the supply of
money in the economy. For example, if a central bank wants to slow down inflation, it might raise
interest rates to make borrowing more expensive, which in turn will slow down spending and cool off
the economy. Similarly, if a central bank wants to stimulate the economy, it might lower interest
rates to encourage borrowing and spending.
For example, let’s say the inflation rate is 2% in a country, this means that the prices of goods and
services are increasing by 2% on average. A person who used to buy a loaf of bread for $1, will now
have to pay $1.02 for the same loaf of bread. The same goes for other goods and services, the prices
of all goods and services will increase by 2%. This decrease in purchasing power means that the same
amount of money will buy less than it did before. In order to maintain their standard of living, people
will need to earn more money or cut back on their spending.
Inflation can also affect various groups of people differently. For example, people on fixed incomes,
such as retirees, may find it harder to make ends meet as prices rise because their income does not
increase with inflation. Similarly, people with savings may see the value of their savings decline
because inflation reduces the purchasing power of their money.
Inflation can also have an impact on businesses. Higher inflation may lead to higher costs of
production, which can lead to companies raising prices to maintain their profits. This can also lead to
businesses facing increased competition, as consumers look for lower-priced goods and services.
In conclusion, Inflation is an important economic indicator that measures the rate at which the
general level of prices for goods and services change. It can be caused by various factors such as an
increase in demand, an increase in production costs, or an expectation of future inflation. Central
banks use monetary policy to control inflation and keep it within a target range to ensure a stable
economy. Inflation affects different groups of people and businesses in different ways, and it can
lead to changes in spending and investment patterns.
But what is the effect of inflation on the stock market?
With high inflation, prices will rise hard and cause companies to sell less, this is because consumers
will mainly postpone their consumption behaviour and pay more attention to their money. As a
result, this causes uncertainty in the stock market, and stock prices generally fall. In contrast, with low inflation, consumers are inclined to spend more money, so businesses will get back to running well and the economy will generally improve. An inflation rate of around 2% is good, this makes money worth slightly less and less, but consumers are still inclined to buy things and not put it off.
GDP
Gross Domestic Product (GDP) is the value of all goods and services produced within a country’s
borders in a given time period. It is widely used as a measure of a country’s economic output and is
one of the key indicators of a country’s overall economic health.
The chart below shows the GDP annual growth rate of the USA over the past 10 years.
GDP influences the stock market in several ways. Firstly, a strong GDP growth signals a healthy and
growing economy which attracts investors, as it generally leads to an increase in corporate profits
and consumer spending. This in turn leads to a positive impact on stock prices, as investors are more
likely to invest in companies that are likely to experience growth.
On the other hand, a weak or negative GDP growth can have the opposite effect, leading to
decreased corporate profits and consumer spending, which can cause stock prices to drop. For
instance, during a recession, when the economy is in a contractionary phase, companies may see a
decrease in revenue and profits, which can result in lower stock prices.
Furthermore, changes in government spending, interest rates, and exchange rates can also affect the
stock market. If a government increases its spending, it can stimulate the economy, which can lead to
higher stock prices. On the other hand, if the government cuts spending, it can lead to a decrease in
economic activity and a drop in stock prices. Similarly, changes in interest rates can also have an
impact on the stock market, as higher interest rates can lead to a decrease in consumer spending and
corporate investment, causing a decline in stock prices.
In conclusion, GDP is a crucial metric that provides insight into a country’s overall economic health,
and its performance can have a significant impact on the stock market. Investors use GDP data, along
with other economic indicators, to make informed investment decisions, and changes in GDP can
have a direct impact on the stock prices of individual companies and the overall stock market.
Unemployment rate
The unemployment rate is the percentage of the labor force that is without work but actively seeking
employment and is available to work. It measures the labor markets health and is a key indicator of
an economy’s performance
The chart below shows the unemployment rate of the USA over the past 10 years.
The unemployment rate can have a significant impact on the stock market, as changes in the labor
market can indicate changes in consumer spending and corporate profits. When the unemployment
rate is low, it generally means that more people have a steady income, which can lead to an increase
in consumer spending. This, in turn, can boost corporate profits and lead to a positive impact on
stock prices.
On the other hand, when the unemployment rate is high, it means that there are fewer people with a
steady income, which can lead to a decrease in consumer spending and lower corporate profits. This
can cause a negative impact on stock prices, as investors are less likely to invest in companies that
are prone to a decrease in revenue and profits.
Furthermore, changes in government policies and regulations can also impact the unemployment
rate, which can have a direct impact on the stock market. For instance, if the government
implements policies that encourage hiring and job creation, it can lead to a decrease in the
unemployment rate and a positive impact on the stock market. On the other hand, if the government
implements policies that make it harder for businesses to hire and create jobs, it can lead to an
increase in the unemployment rate and a negative impact on the stock market.
In conclusion, the unemployment rate is a crucial metric that provides insight into the health of the
labor market and the overall economy. Changes in the unemployment rate can have a direct impact
on consumer spending and corporate profits, which in turn can have a significant impact on the stock
market. Investors use the unemployment rate, along with other economic indicators, to make
informed investment decisions.