In this blog post, we’ll explore how corporate earnings forecasts impact stock prices and examine the relationship between interest rates and stock prices. It might seem a bit complex at first, but grasping the core flow makes it easy to understand.

Forecasts and Expectations Drive Stock Prices

Corporate earnings forecasts are always highly volatile. Even the most solid blue-chip companies don’t see their stock prices remain constant. Some days they surge sharply, while other days they plummet without apparent reason. It’s common to see stock prices move more than 10% in a single day. Why does this happen?
This is because stock prices are not merely a reflection of current performance but a comprehensive outcome that incorporates expectations and forecasts for the future. In particular, the market’s expectations regarding a company’s future performance play a decisive role in shaping its stock price.
Therefore, when new information emerges or existing information changes, investors reassess the company’s future performance, and the resulting revaluation is immediately reflected in the stock price. Thus, stock prices are fundamentally influenced by psychological factors like ‘expectations’ and ‘predictions’.

Two Pillars Influencing Earnings Forecasts: Macroeconomic and Microeconomic Factors

So, what information impacts a company’s future performance? This can be broadly categorized into macroeconomic and microeconomic factors.

Macro Factors: Economic Trends and Government Policy

Macro factors encompass the overall national economic situation, industry trends, and government policies that extend beyond individual companies. These elements impact not just specific firms but entire industries or the broader market.
For example, suppose the government announces a policy to fully support the renewable energy industry. In this case, companies within that industry are likely to receive various subsidies and tax benefits, gaining a favorable position in technology development and export expansion. If a company previously projected to sell 100,000 electric vehicles annually is now expected to sell over 200,000 due to the new policy, its stock price will inevitably rise significantly.
Policy changes raise earnings expectations, and those expectations drive stock price increases.

Micro-level Factors: Individual Company Strategy and Competitiveness

Conversely, micro-level factors refer to internal changes within individual companies. These include management strategy, technological capabilities, product competitiveness, shifts in market share, and mergers and acquisitions (M&A).
For example, news that a company has developed groundbreaking new technology or signed a strategic cooperation agreement with a global conglomerate raises expectations for its future performance, causing its stock price to rise accordingly.
Ultimately, both macro and micro factors influence a company’s future performance, which in turn drives stock price fluctuations.

The Key Variable with Immediate Impact on Stock Prices: Interest Rates

So, what factor has the most immediate and powerful impact on stock prices? It’s interest rates.
Interest rates may seem like a somewhat complex concept, but fundamentally, they represent the expected rate of return an investor can anticipate when investing in a financial asset. For example, if you deposit $10 in a bank and it becomes $10.40 after one year, the interest rate is 4%.
However, the ‘interest rate’ we discuss isn’t limited to deposit rates. It’s a general concept encompassing the expected return on all investment products, including bonds, stocks, and real estate. The interest rate for each product varies based on the asset’s risk level; higher risk demands a higher return, meaning a higher interest rate.

Core Concepts of Interest Rates: Required Rate of Return and Risk-Free Rate

A crucial concept to understand regarding interest rates is the required rate of return. This represents the minimum return an investor expects when investing in a specific asset. If this benchmark isn’t met, the asset loses its investment appeal.
The required rate of return consists of two elements:

Risk-Free Rate:
The rate of return achievable without any risk, typically benchmarked against U.S. Treasury bonds (10-year).

Risk Premium:
The additional return demanded based on the inherent risk level of the specific asset.

This can be expressed as a formula:

Required Rate of Return = Risk-Free Rate + Risk Premium

For example, bank deposits offer low yields because they carry almost no risk of principal loss. Conversely, corporate bonds or stocks require higher yields due to the various risks involved. Thus, interest rates serve as a ‘reward’ for the risk investors must bear.

Interest rates and stock prices move inversely: Negative Correlation

The relationship between interest rates and stock prices generally exhibits a negative correlation. This means that when interest rates rise, stock prices tend to fall, and when interest rates fall, stock prices tend to rise.
This phenomenon can be explained by the Asset Pricing Model. When interest rates rise, the returns on safe assets like deposits or bonds increase. Consequently, there is less need to take on risk by investing in stocks. This reduces demand for stocks, causing stock prices to fall.
Conversely, when interest rates decrease, the returns on safe assets fall. Investors then shift their funds to the stock market, where they can expect higher returns. Consequently, stock prices rise.

In conclusion: Stock prices are the result of predictions; interest rates are the benchmark for those predictions

In summary, stock prices reflect the collective market prediction of a company’s future performance, while interest rates serve as a crucial benchmark for setting that prediction’s baseline. Accurate interpretation of stock price movements requires comprehensive consideration of policy changes, industry trends, individual corporate capabilities, and macro-financial factors like interest rates.
The stock market is constantly moving and changing. Therefore, it requires insight to read the background and structure behind the numbers, not just looking at the numbers themselves. As your depth of understanding grows, your perspective on the market will also become more sophisticated.