Why Does the Stock Market Move up and Down? Part -2


Optimism and Pessimism of Market Participants

In addition to the interest rate, the optimism or pessimism of the market participants can have a big effect on the direction of the stock market. In the Malaysian/Singaporean market, most of the shares are held by insiders with only a small proportion left to be bought and sold by the general public. Much of the market action is caused by the so called “floating investors” who only take part whenever the mood suit: them. If the market participants are very optimistic, this will result in many people chasing very few stocks. The imbalance between supply and demand would lead to very sharp price changes. When they become pessimistic, they would try to unload their holdings. However, since the floating investors tend to think alike, only a few people will pick up the shares. This would lead to a sharp decline in prices.
As we have noted in the first part of this chapter, the investors’ mood is directly affected by their immediate past experience, especially the small investors who have little else to guide them. Thus, they would be at their most optimistic after the market has experienced a period of strong rise. In contrast, they would be at their most pessimistic after the market has suffered a sharp decline. Yet because the market is always cyclical, their mood will lead them to continually enter and leave the market at the wrong time. When they are at their most optimistic, it is likely that the shares are at their most overvalued. That is hardly the time when long term investors would want to buy. It would be much better to wait until they are at their most pessimistic, that is, when volume of trade has been very low for some time and the brokers’ offices are empty.

Political and Social Factors

Political and social factors can have powerful effects on the stock market. The May ’69 Incident is a good example as is the assassination of Senator Aquino in the Philippines. It is impossible to tell in advance what social or political upheaval can take place that will have a disastrous effect on the stock market. One thing is clear however. The higher the stock market, the more susceptible it is to the forces of market sentiment. If the market is very low, even big political upheavals would have minimum effect on its level. On the other hand, if the Market is very high. even a small wobble an cause it to come crashing down. It is noticeable that because price level in I969 was already low, wen the May ’69 incident did not cause the prices to fall as much as one would expect (only in the region of 30 per cent). I would hazard a guess that if the same thing were to happen in late l987, the stock market could have easily collapsed by 75 per cent. Witness the fact that the Private Adam fiasco led to a l2 per cent drop in prices over one day even before the October 19th Crash took place on Wall Street. Owing to the existence of many factors which can affect the demand for shares over the short term, short term share prices tend to be very unstable. As a result, it is risky to invest in the short term. One’s prediction can easily go haywire. However, over the longer term, such short term factors tend to self-cancel. Interest rate is normally cyclical. Investors too go through cyclical fluctuation in their mood. Over the long term therefore, different forces are at work to determine the level of the stock market. Let us now turn to the long term.

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