Equity Funds - What affects price? - Fiscal Agents Money Management Newsletter

Mutual Fund Investing

Savings

Managing Money

Choosing Fin.Services

Insurance Products

RESP Savings

Taxes / Estate Matters

Subscription Services

Glossary of
Financial Terms

Click above to find out how Fiscal Agents can assist you on investing in Mutual Funds.

Now Quick-Nav enabled!
Use this link to connect you directly to additional useful information related to Mutual Funds.

The Companion Advisor: Mutual Funds
Equity Funds - What affects price?

A Companion Advisor Article

Equity mutual funds usually have a short-term history of going up and down, but most investors learn to withstand temporary volatility for significant long-term gains.

"Canadian Stocks, Bonds, Bills and Inflation: 1950-1987", a study written by Dr. James Hatch and Dr. Robert White, compared various investments over time. For one-year periods within their time frame, stocks did not provide significantly greater returns than bonds or T-bills. However, for ten-year periods, which included the 1987 tumble, stocks outperformed bonds and T-Bills in 29 of the 32 periods from 1950 to 1991.

As well, the compound annual return on stocks from 1950 to 1991 was 10.8 per cent, well ahead of the 6.6 per cent for bonds and the 6.4 per cent for T-Bills. The study suggested that an investor's potential returns on stocks will exceed the potential returns on bonds and T-Bills as long as the investor holds the stocks for at least five years.

What factors influence the price of stocks, and therefore the value of equity mutual funds? There are several fundamental factors: expectations, external events, fiscal and tax policies, government spending, monetary policy, inflation, and business cycles. Technical factors include: the condition of securities markets, price movements, trading volume, and supply and demand.

Fundamental factors include everything outside the security markets themselves which might influence price. Because market security prices are negotiated between buyer and seller, future expectations help determine price. Present information helps determine future expectations but, because people have different access to information and interpret information differently, buyers and sellers are usually able to strike a deal. External events such as wars, earthquakes, and crop failures can have major impacts on equity prices because most equities, unlike bonds, have no fixed terms or returns.

Government fiscal policies may influence stock prices. At its simplest, government spending is usually stimulative, and will support the stock prices of certain industrial or social sectors, as long as it is not too inflationary. Tax increases tend to dampen consumer spending and business profitability while tax cuts may spur the economy and boost profits and common share prices.

As well, the levels and targets of government spending can affect business profitability and share prices. Governments can direct spending to assist specific economic sectors. Import policies may help or hurt particular industries, and policies such as the dividend tax credit may encourage share ownership. Monetary policy may be directed toward restraining the growth of money and credit during excessive economic expansions, and vice versa during contractions. This has an effect on the activities and expectations of businesses, and their share prices. Market participants may change their interpretations of future Bank of Canada policy, thus altering their expectations and the price they are willing to pay for common shares.

Inflation tends to create uncertainty, increase inventories, and drive up labor costs, all of which usually depresses common stock prices. Also, since depreciation allowances are pegged to the original cost, not replacement cost, true costs of doing business in inflationary times are usually understated. The tax burden of corporations increases because pre-tax profits become overstated. This will serve to reduce share prices.

Inflation also drives up interest rates, either as a matter of government policy or as an "inflation premium" demanded by lenders to compensate them for a future decrease in purchasing power. This increases the cost of loans, decreases business profitability, and decreases share prices.

Business cycles, irregular increases and decreases in economic activity, also have an influence on stock prices. There are many theories about what causes business cycles. Some say technological innovations or political events create expansions and contractions in business activity. Other argue that imbalances between production and consumption create the cycles; growth is caused by consumer demand which causes manufacturers to expand their production. Eventually, production exceeds demand, businesses cut back, unemployment increases, and demand falls until consumers can no longer postpone new purchases, at which point growth begins again.

Broad changes in common stock prices generally coincide with business cycles, but it is very difficult to predict when cycles will begin and end, and which stocks will be affected. It is generally best for most equity investors to practice dollar-cost averaging or rely on a good mutual fund manager to make specific market decisions.

Over the long term, equity investments usually outperform other investment types, providing you can weather occasional volatility. Knowing some of the factors which influence equity prices can prepare you for the ups and downs.

Like on a boat cruise, equity investors sometimes have to withstand a queasy stomach to get anywhere.