What are the key drivers of equity

Key Drivers of Equity: Check Inflation, Interest Rates, Growth

In the world of equity trading, people are more aligned to make profits in a short period of time. The equity market seems to provide return as well as losses to the investor. For equity trading you can go through the key drivers of equity and other factors.

Equity markets are uncertain and volatile. Hence it is impossible to predict the direction of markets with no degree of certainty. Therefore, to trade equity, you must understand what drives markets and how these factors drive the equity markets.  Why is it that sometimes markets tend to crack sharply and sometimes the same set of equity stocks tend to be on a perpetual bull market? The equity markets offer you a broad spectrum of options, from basic equity to commodity stocks to brands and service companies. The list is endless. The most important thing is knowing what is driving the equities in stock markets so that you can take meaningful positions. As Peter Lynch used to say, buying stocks at random is likely playing poker with your eyes closed. You have as much of a chance of success in such cases.  

Today, online equity trading allows you to take positions on your own, sitting in the comfort of your home. However, this do-it-yourself (DIY) trading also places the onus of research and monitoring on the investor. Therefore, one of the best ways to go about your online equity trading is to start with an understanding of the critical drivers of equity markets. These key drivers of equity can be beneficial for you in multiple ways.

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Some of the key factors of Equity Trading is as follows:

Inflation and Interest rates

• In the case of inflation and interest rates, the impact is more direct, more immediate and experienced at multiple levels. 
• Let us look at inflation first. It reflects the general rate at which the prices of goods and services in a country are moving. 
• High inflation means that prices are moving up very rapidly. Currently, the world over, inflation is at a new high. In India, the consumer (CPI) inflation at 7% is above the 6% outer limit prescribed by the RBI. The wholesale producer inflation (WPI) is above 15% and reflects the extent of supply-side constraints. High supply-side inflation usually is negative for markets as they push up the cost of manufacturing and compress the operating margins of Indian companies. Higher inflation also perks up expectations of interest rate hikes, pushing the bond yields higher. 
• Higher interest rates can hurt the stock markets in 3 ways. Firstly, higher yields mean companies have to borrow in the market at higher rates. That pushes the cost of borrowing and adds to the solvency risk. 
• Secondly, the key drivers of equity in case of higher interest rates also mean that individual borrowing appetite comes down. That pushes down consumption demand.
•  Lastly, valuations are based on the cost of capital by discounting future cash flows. When interest rates go up, the cost of capital goes up, and hence the discounted value of future cash flows comes down. This depresses the valuation of stocks.

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Currency, liquidity and FPI(Foreign Portfolio Investment) flow.

• In this key drivers of equity, Currency and liquidity are dependent on each other.  
• Most FPIs(Foreign Portfolio Investment) would prefer the rupee to remain stable so that their dollar returns don’t get impacted.
• If the rupee weakens, then actual returns are impaired. For example, if the portfolio of an FPI appreciates by 15% and the rupee depreciates by 9%, then the dollar returns are just 6%. That is why most FPIs are wary of investing when the rupee is either weak or likely to weaken further. Liquidity flows are usually determined by retail appetite, mutual fund appetite, FPI buying and purchases by passive index and ETF funds. Liquidity is a key factor in determining the direction of equity markets like India.

Greed and Fear

• The basic market rule of trading is to be greedy and buy stocks when the markets have corrected sharply. 
• At the same time, the other rule is to be fearful when markets have gone up too fast. 
• In reality, this is a game of psychology and behavioral finance. Most people don’t behave rationally because they are dealing with real money, and this is their own money. 
• Most of the research reports advise you to buy in the markets. Similarly, people panic and exit at a loss when their needs are low. This mismatch in applying greed and fear usually triggers the market's direction. 

Company profits, growth and margins

This does not need much elaboration. What do stock markets prefer to see in company profits? Here is a sample of important key drivers of equity

• Markets expect steady and consistent growth in sales and profits. Operating margins must be gradually increasing over time. 
• The company must be using its assets efficiently to maximize ROI Investors don’t like too much leverage as it impacts the solvency and coverage. 
• Between dividends and retention, investors prefer retention of profits for growth. The advantage of dividend and tax-paying companies is the assurance of tangible gains.  

Typically investors gradually gravitate towards companies that meet these profitability, growth and leverage conditions. 

Stock market valuations

• The most important way to look at market valuations is through the price-earnings ratio (P/E) ratio to gauge market valuations. However, other types of parameters are also considered for valuations.  
• Other than that the price-to-book value is often used in the case of banks. The EV / EBITDA is used for long gestation capital-intensive companies. The dividend yield is also used to set a base case for valuations.