Equity markets are full of volatility and rollercoaster gyrations, where emotions can often lead to distraught investors and hasty decisions. When this occurs, emotions override logical fundamentals leading to trades that spook individuals interested in investing in the equity markets. Jim Cramer once noted that “[w]hen we become scared and confused investors we become emotional and reckless investors” (intentionally italicized).
A recent example of volatility that was due to little news of import or underlying reasoning was the infamous Flash Crash on May 6, 2010. After a rough morning of futures trading, the American markets opened in choppy conditions due to an overload of traders placing massive sell orders. Thus, equity values of blue chip companies with rock solid dividends, such as Proctor & Gamble (PG), saw their market cap fall tremendously in a matter of minutes. Rational investors saw this tumble and understood there was nothing fundamentally wrong with these companies. This spurred an intraday rally that propelled these stocks all the way back up. Talk about a massive buying opportunity.
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Despite random gyrations like the event in the paragraph above, there are two main influencers on equity markets. First, macro conditions heavily impact the way traders view equities and their value. For example, economic influences domestically and globally have a significant impact on which direction a stock heads in terms of value. Economic influences include jobless claims and employment data, which are reported the first Friday each month. Whenever the Federal Reserve makes an announcement or has an official speak the markets place heavy emphasis on their words. Aggregate retail and home sale numbers affect consumer discretionary companies in addition to the financials. Finally, overseas events sometimes wane on domestic stocks even though there may be no exposure to that market by that firm.
One of the new perplexing questions asked by novice investors is how do sectors affect the individual companies. For instance, why do low performing firms pull down successful companies in the same sector? Or if several firms in a specific sector are excelling, why does this pull up the laggards despite their hideous performances?
Micro events are those specific to individual firms and are not related to the overall markets. These include earnings announcements, quarterly sales figures, divided raises, and buying back stock from the market. Micro events are not a byproduct of macro conditions. Although micro events related specifically to a firm may be due to macro conditions, micro events will not pull down other related securities.
There are many reasons as to why stock prices gyrate and move in ebb and flow patterns. Over the next few weeks I will continue to break down each of these points mentioned above to help you better understand what is causing stock prices to move. Mastering this understanding will help you become a better investor and assist in your stock picking.
