Why are the economic analysis and in-depth understanding of economic factors is important for effective decision making in the capital market?
Investors always try to formulate the best possible portfolio by investing in the capital market for the purpose of getting capital gain and dividend (cash or stock). It is not an easy task to choose the best investment alternatives because the proper analysis is required. Only a specialized person would be able to analyze the market and identify the potentials. Many people think that only financial analysis is enough to make an investment but in a real sense, not only financial analysis but also economic analysis is required.
Factors are Important for Efficient Decision Making
In the case of financial analysis, we only consider the company and industrial outcome through fundamental and technical analysis. But whenever we go for analysis by considering economics we have to analyze the macroeconomic factors that may have an impact on the capital market. An economist or any other professionals those have knowledge of economics can do this analysis on behalf of investors. But investors also have to have basic ideas of how economic factors can influence the price of the investment securities.
- Market Interest Rate
- Economic Recession
- Employment Rate
Effect of Inflation in the Capital Market
In an inflationary economy, investors have less money to invest because investors have to spend more money on their consumption. As because there is less demand for the stock in the capital market, the price should be lower; we know that lower the demand lowers the price. In the other sense in the case of a company, for inflation, the production cost of the company is higher than the previous. So the company’s income will be lower than stimulates the price of the stock. We know that the stock which provides more dividends to the stockholders, that stock should price higher than the other company which provides lower dividends.
Effect of Market Interest Rate in the Capital Market
If the market interest rate increases then an investor will prefer fixed income securities rather than lower-earning risky securities. Suppose a government bond providing 10% of interest then this bond will get more preference compared with risky investment. On the other hand, if the interest rate is lower in the market then an investor will borrow the money at lower interest and invest in the capital market.
Because of the economic recession, there may have a positive impact on the capital market. Normally at the beginning of recession investor loose but there is always an expectation that in near future there will be positive movement in the stock price in the market, so investor prefers to invest when there is a recession. This will happened only if there is a strong form of efficiency that exists in the market.
On the other hand, if there is an economic boom situation that exists then there may have a possibility of declining market price movement.
With the increase in the number of employees in a country per capita, income will also increase. These people will have extra money after consumption. If people capital market is performing well then an investor will be interested to invest their surplus amount of money. So higher the employment higher the earning and it does increase the investment in the capital market.
Political Condition of a Country
Political condition is one of the main factors which have a huge impact on the overall economy and the capital market. People believe that a positive economic condition is required to maintain a stable capital market. Several financial decisions taken by the government over time to time, so it is also important to know how much preference a capital market gets from the government.
In capital market investors basically, invest in long-term security so the investor must consider all probable aspects and economic factors before making an investment. A choice of investment in the capital market can lead to a huge capital loss, so proper analysis has to done by the professional and select the best opportunities.
Finally, one thing is that an investor should consider economic factors that have an impact on the capital market and proper financial and economic analysis must be done before investing in the capital market.