The Role of Supply and Demand in Shaping Stock Market Fundamentals

It is interesting to know why some prices soar and some dive in the stock market. The prices swing like a pendulum, and have you ever wondered what is responsible for these movements? At the core of every market fluctuation are the forces of supply and demand. Let us dive into this blog to discover how these critical elements shape the fundamentals of the stock market.

How Does the Law of Supply and Demand Affect the Stock Market?

The law of supply and demand explains the link between the availability and want of a product and its price. It determines the pricing of stocks and other securities in the financial market. Economic data, interest rates, and corporate results impact the demand for stock market basics. Market dynamics, financial situations, and changes to monetary policy influence the supply of stocks. Understanding supply and demand for stock gives you a sense of how the edge in initial public offerings spinoffs can help you make smarter investment decisions.

What are the factors that impact Stock Demand?

 There are a few factors that impact stock demand, as discussed below:

Economic Data:

• Economic data provides insights into the overall stability of the economy.
• When the economy functions better than expected, it affects the stock market basics. Demand for stocks increases as investors foresee higher future earnings.

Interest Rates:

• Rising interest rates reduce the demand for stocks as the risk-free rate of return becomes more tempting.
• With the improvement of the economy, interest rates generally increase. This can simultaneously improve stock demand, creating a balance between these forces.

Corporate Results:

• Factors like profits, sales, margins, and future outlook are essential in shaping the demand for individual stocks.

Volatility often increases before and after companies release their quarterly and annual results. Investor reactions to financial forecasts also drive it.

What causes stock prices to change?

There are several reasons for stock price changes, some of which as discussed here:

Stock Prices Change because of Market Forces:

• Prices vary based on supply and demand.
• If demand exceeds supply, the price rises, and if supply exceeds demand, the price dips.
• Advisory Insight: Financial advisors closely monitor supply and demand trends to guide buying or selling stocks. Financial advisory services can analyze market conditions and investor behaviour to forecast price movements and help make informed decisions.

Understanding Supply and Demand is Easy, but Investor Sentiment is Challenging:

• What is interesting and what is not in stock is difficult to predict and varies based on news, strategies, and investor opinions.

Price Movement Mirrors Investor Perception of Value:

• A stock’s price shows how investors feel about the company but doesn’t necessarily reflect the actual value.
• Market Capitalization is a more accurate measure of a company’s value (stock price × number of shares outstanding).

Stock Prices indicate Future Growth Expectations:

• Stock Prices present market value and manage investor expectations for future growth.

Earnings Are the Key Factor Affecting Value:

• Earnings are vital to a company’s survival and drive long-term value.
• Positive or negative earnings reports can cause stock prices to rise or fall.

Other Factors Beyond Earnings Influence Stock Prices:

• Factors like investor sentiment, trends (e.g., the dot-com bubble), and market speculation can also impact stock prices.
• Numerous ratios and indicators (e.g., P/E ratio, MACD) are used to analyse stock performance.

Stock Price Prediction Remains Uncertain:

• However, there’s no definitive way to predict stock price movements, though some rely on historical trends or technical analysis.
• Remember the stock prices are highly volatile and can change rapidly.

Impact of External Factors on Supply and Demand

Certain external factors influence the demand and supply forces worldwide. Some of them are discussed here:

• Political: The political and legal situation directly impacts the demand and supply dynamics worlwide. Businesses in regulated sectors like pharmaceuticals, brewing and tobacco get affected with changes in supply chain that could affect supplier’s compliance resulting in inventory challenges.
• Economic: Changes in the economic environment, including consumer income, interest rates, and exchange rates, are directly proportional to supply chains. For instance, for an FMCG industry, changes in the economy can impact material costs, inventory strategies, and labor availability, which has recently been highlighted by shortages in logistics roles.
• Social: Changes in work trends owing to COVID 19 pandemic gave rise to remote working and e-commerce which reshaped supply chain to a great extent. With the closure of retail businesses , industries adopted e-commerce accentuating the need to adjust supply strategies.
• Technological: Swift technological advances will impact industries and supply chains. The accelerated development of the COVID-19 vaccine is a prime example, creating challenges for logistics and cold supply chains. New emerging technologies like AI and Big Data will further transform sectors and require new supply chain strategies.
• Environmental: Environmental concerns are taking a growing role in reshaping supply chains, with companies increasingly focused on reducing their carbon footprint. Initiatives like Deposit Return Schemes (DRS) for single-use plastics are in the future pushing companies, mainly  in FMCG, to adjust their operations.
• Demographic:Demographics are a pivotal driver of future supply chain changes. For example, India’s rapidly  growing young population, hence increasing urbanisation, will result in  shifts in labour markets and consumer demands. Companies must anticipate these trends, such as the rising middle class and the growing demand for technology and consumer goods, and adapt their supply chains to meet the evolving needs of the market.

Real world examples

Here are some examples of demand and supply across the world with Indian contexts as well:

Global Examples:

1. Oil Prices (2008 Financial Crisis): During the 2008 financial crisis, a substantial drop in global demand for oil due to economic slowdown resulted in  a sharp decline in oil prices. This drop was an example of how reduced demand can drive prices down when supply remains constant or exceeds demand.
2. Semiconductor Shortage (2020-2021): The COVID-19 pandemic induced  a global shortage of semiconductors. In the beginning, many industries reduced their orders due to decreased demand, but as economies began to recover and demand for electronics increased, supply chains could not keep up. This gap led to production delays and increased prices for a range of electronic goods.

Indian Examples:

1. Agricultural Produce Prices: In India, the prices of agricultural products often fluctuate due to supply and demand imbalances. For instance, we may have seen that during the monsoon season, if there is an excess of a particular crop like onions due to favourable weather, the supply increases, leading to a drop in prices. On the other hand, during droughts or poor harvests, supply decreases and prices rise.
2. Mobile Phones Market: The Indian mobile phone market is another example where supply and demand dynamics are exemplified. For instance, during the launch of popular smartphone models from brands like Xiaomi or Samsung, high demand often leads to initial shortages. As supply catches up with demand, prices stabilise. Moreover, seasonal sales and promotions can drive demand spikes, affecting supply and inventory strategies.

Conclusion

The synergy between supply and demand is key in shaping stock market dynamics. These twin forces cause price fluctuations, influence market sentiment, and determine the valuation of assets. Understanding their impact helps investors navigate market volatility and  provides insights into the broader economic landscape. As supply and demand continue to evolve, staying attuned to these factors is crucial for making informed investment decisions and anticipating market trends and risks.