Stocks Growth Rate
Why do interest rate, employment data, economic growth rate, & consumer price index effect the stock exchange?
In theory, a stock’s price should be equal to the present value of all of its future cash flows. Anything that causes the cash flows to get bigger or smaller has an effect on price. But given that cash flows don’t change, the price can still change if the interest rate changes.
Let’s look at an example. Suppose that you have a company that has paid all of its bills for the next year. In one year, it gets a $100,000,000 payment for sure. At that time, the payment will be distributed to all owners of the firm & the firm will disolve. How much is the firm worth? We know it will be worth $100MM in a year. What is the right interest rate. Suppose is it 10%. Can we find the value of the firm now? Sure — it is the amount that if we invest it at 10% it will be worth $100MM in a year. That is, it is worth $100MM/1.1 or $90,909,090.91 now.
OK — what happens if interest rates change. Perhaps they go up to 11%. Then the value of our firm changes to $100MM/1.11 = $90,090,090.09 — losing almost $82K in value. If rates go down, the value should go up.
Next, let’s look at CPI. This is the rate of inflation. If it increases, people will think that they need more money to have the same lifestyle in the future. If they are worried about inflation, they will demand a higher interest rate to compensate them for higher prices in the future. So, changes in expected inflation change the interest rates, and therfore change stock prices.
What about the economic growth rate? If the economy grows faster than expected, then maybe that $100MM that we thought the company was going to get will be higher. A higher payment translates into higher stock prices.
As for employment, it turns out that the employment rate is associated with growth. If a lot of companies are hiring, then there will be more money spent by the new employees, and there will be more produced by those new employees, so demand for goods goes up. This causes an increase in the expected profits, and higher stock prices. It isn’t quite so simple, though. If there are too many people working, then the demand for labor causes higher costs and lower profits, which causes stock prices to decline.
10/22 China’s Growth Rate Continues To Grow