What Affects the Movements of Asset Classes?
Following our discussion of correlations of different assets, let us now examine factors that influence an asset's price movement.
Macro Factors influencing asset price movements
The following factors are the most commons ones, that would affect the movement of almost all the asset classes
1.GDP Growth Rate
Gross Domestic Product (GDP) is the sum total of all goods & services produced in an economy in a given time period. Whether you buy a pen from a stationary store or a car from an automobile store, all these transactions are accounted for under the GDP of a particular year. Since the economy is all about transactions and growth in transactions would necessarily mean a higher income. Hence for a top down investor, GDP growth rate is the closest estimate of economic health.
When we talk about Interest rates, we generally refer to the yield of long term government bonds, more specifically the ten year maturity. As you would already know that interest rates impact the economy on the whole and therefore would have an indirect impact on all the asset classes. In case of bonds, interest rates have a direct impact and are usually inversely related. For example, a drop in interest rates would generally mean an increase in the bond prices.
Inflation is the rise in the prices of the asset classes over a period of time. Suppose, today a dosa costs you ₹50 at the nearby Udupi restaurant, and the next year, the restaurant owner suddenly increases the price of dosa to ₹55. This means that the inflation in the price of dosa for the year is 10%. Obviously, while calculating the national inflation, Udupi dosas are not accounted for individually, however, the central bank tracks the prices of a basket of goods consisting of food, fuel, clothes, etc. to get an average price increase for the year.
Inflation is a necessary evil. While no one will like the price of her favorite Dosas rising every year, a falling inflation (called deflation) is even more undesirable as it would lead to deferment of purchase and impact the GDP figures negatively. An inflation which is within the range desired by the RBI (currently 2-6%) is considered healthy for the economy.
4.Corporate Profit and Unemployment
Corporate profit and unemployment are inversely related. When the corporate profitability goes up, it usually leads to a rise in employment activity. An upward trending corporate profitability graph and downward trending unemployment graph is desirable.
Sentiment is a very important aspect of the financial markets. With the rise in analytics and machine learning, various hedge funds have deployed strategies that buy and sell assets based on the sentiment analysis of the market. For example, if there is a trending discussion about a stock on reddit, the algorithm would judge the sentiment (positive/negative) and suggest trades accordingly.
Investor sentiment has a huge role to play in the market movement and momentum.