When looking at stock prices, analysts evaluate both the macro environment, which includes growth in the country, inflation, and consumer demand. Analysts also examine in detail the microeconomics, which consists of the revenue the company generates and earnings and future guidance.
By evaluating the macroeconomic and microeconomics of trading, an analyst will have a gauge of the supply and demand for that asset and be able to estimate the future value of a security. In this article, we delve further into how micro and macroeconomics determine stock prices, starting with an explanation of these two terms and their role in trading capital markets.
Microeconomics is the study of the behavior of individuals and firms’ decisions in their narrowly-defined markets and the impact of economic policies. For example, a change in tax rate or new regulations may increase or decrease production and change the price and volume of sales. There are many models in this study, including:
Some of the models utilized in the study of business and individuals include:
- Supply and Demand
- Market Structure
- Game Theory
Macroeconomics is defined as a field of economics that evaluates the performance, and behavior of an economy as a whole.
Macroeconomics generally deals with the overall economy and focuses on specific indicators that provide economists with a view of how a nationwide or statewide economy will perform. Some of the more common indicators used to evaluate macroeconomic performance are Gross Domestic Product, inflation, and job growth.
The models are aggregates of the same models used in microeconomics. For example:
- AD-AS model
- IS-LM model
- Growth models including neoclassical growth theory and it’s challenger the endogenous growth theory
The Macro Economics of Trading
Depending on the asset you are trading, each one will have different macro and microeconomics that drive the future value.
The theory behind macroeconomics related to the capital markets is different for the different capital market securities that are traded. For example, when growth increases in tandem with inflation, bond prices generally fall, but equity prices and commodities are rising.
Rising inflation will increase the yields within a country and will generally buoy a currency. The stronger the yields, the more attractive a currency is relative to its peers.
The Microeconomics of Trading
The microeconomics of trading refers to the performance of specific companies and how changes can affect an asset. This asset could be a company or even a commodity. For example, the lackluster performance of a gold miner could affect how the company performs and the volume of gold available.
The way that analysts evaluate the microeconomics of a public company is to sift through their financial information. Most public companies worldwide provide investors with financial information that describes their earnings, revenues, cash flows, and operating income. These metrics provide a backdrop for investors to determine company value and specific sector performance.
If the financial results of a large company in a specific sector provide microeconomic information about the company and include information about the industry. The revenues inform on sales and consumer demand, and it’s also an indicator of the costs that are either generating headwinds or tailwinds for the company.
Macro and microeconomics are vital factors that help determine the value of an asset traded in the capital markets. Macroeconomics helps evaluate the performance of an economy. Microeconomics is the study of individuals and firms making decisions in narrowly-defined markets.
By evaluating both the macroeconomic and microeconomics of trading, an analyst with a firm, specializing in Index Funds Canada will gauge the supply and demand for an asset and be able to estimate the future value of a security. It’s important to remember that changes to both macroeconomic and microeconomics will affect each safety differently.