- LATIN AMERICA
- MIDDLE EAST
- United Kingdom
- United States
- New Zealand
- South Africa
By Ben Baden
Central banks, market sentiment, and valuation all play a role in stock prices
When deciding how to allocate your stock portfolio to different regions of the world, there are many factors investors should consider.
Here are five factors that drive stock prices:
Stock Price Factor - Market sentiment
On a day-to-day basis, it's impossible to predict what will happen in stock markets worldwide. One week, the market is up on better-than-expected economic indicators, and the next it's down because of a new development in the sovereign debt crisis in Europe. "It's so unpredictable," says Roger Aliaga-Díaz, senior economist with the investment strategy group at Vanguard. "That's one of the reasons that we focus more on the long term."
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Stock Price Factor - Growth expectations
Research over the years has proven that higher GDP growth doesn't necessarily translate into higher stock returns in a particular country. The correlation between the two is actually negative. Take China, for example. From the beginning of 1993 through the end of 2009, China's GDP grew at an annualized rate of 11 percent, which ranked it first among countries represented in the MSCI All-Country World Index (ACWI), according to a research paper released by
Investors should pay attention to analysts' expectations for higher or lower economic growth in a given country. "You want [to invest in] markets where you find GDP growth is accelerating," says Leila Heckman, senior managing director, international equity, at
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Stock Price Factor - Valuation
In the long term, valuation plays an important role in driving stock prices in a given country, says Jay Ritter, a professor of finance at the
Stock Price Factor - Momentum
Despite what's going on in the economy or with a particular company's fundamentals, investors will sometimes trade on momentum. "Often investor psychology can pile on and drive a stock price higher and higher, well above fair value, and that can happen for an extended period until finally there is a correction," says Steve Cucchiaro, founder of Windhaven, a Boston-based investment advisory group. "Conversely, there is a time when stock prices can be pushed down."
Stock Price Factor - Central bank activity
Generally, you want to invest in a country in which the central bank is lowering interest rates. While interest rates remain at virtually zero in the United States, other rapidly-growing nations are being forced to raise rates because of inflation concerns. So while it seems that economic growth would be beneficial for stock prices, too much growth can actually have a negative effect. "As these economies like China and Brazil grow faster and faster, they begin to overheat, then inflationary pressures rise, then the central banks decides that they don't want inflation to get out of hand, so they start to raise interest rates, and usually, that's a long process," Cucchiaro says. "That acts to cut into stock valuations."
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