Why do earnings and fed activity like CPI Reports and FOMC Meetings impact stock prices so much?
In: Economics
There are two parts to this question. The first one is “earnings”.
Earning is a company’s profits. If a company is making a lot of money then it will have a lot of profits and will have high earnings. If a company fails to making money and have to borrow money to pay the bills then it will be in debt and has negative earnings.
If a company is making a lot of money then it will be valuable. The more money it’s made the better it is. Therefore, it’s stocks (a portion of the company) would also increase in value. Vice versa, if a company can’t make any money and have no way to make money in the future then it will not have a good value. Maybe it would be shut down and sold at Goodwill (I am sure the chairs would be). Thus, the stocks would worth very little.
The second part of the question is about the FED – also known as The Federal Reserve Bank or the bank of all banks.
Without a full on lecture on macro economics, we can say that the Fed is a government entity tasked with the sole purpose of keeping the economy growing steadily. If it grows too fast, they will dial it back, if it grows too slow, they will boost it a little bit.
The problem becomes complicated when whatever the Fed is trying to do will take time and whatever indication of how the economy is doing is almost always late. It gets even more complicated when people respond to the information from the Fed without the Fed doing anything.
For example, CPI is the consumer price index. The Fed would send some people out into the supermarket and collect the prices of a bunch of items. If the prices are higher than last time they checked then the CPI would increase and we have inflation. Roughly 2% is considered healthy. Anything higher (or lower) and the Fed will have to act.
The most common way the Fed act is to adjust their interest rate which will determine the borrowing rate of the banks. At really high interest rate, you will have to pay back a lot of money if you borrow. So companies would not borrow anything and they just sit there and wait. Companies that aren’t making profits will be in big trouble because they can’t pay their bills. If the interest rate is really low then companies can borrow a lot of money to expand or pay their bills. They will have more time to figure out a way to make money or just simple make more money.
So the stock of companies tend to go up or down depending on the Fed actions.
However, people are very smart and the Fed actions are almost always the same given the same situation. So, people would act as soon as the Fed gets their information instead of waiting for the Fed to act. The Fed also must discuss their what to do before they do anything (hence the meetings) so people tend to act as soon as they know what the Fed is going to do. They would buy and sell stocks causing the prices to change.
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