‘Action and Reaction’ on the Stock Market

action and reaction

The coach must be sacked. He has lost control of the dressing room. There are divisions in the team. The entire management team must be changed. The team lacks motivation because players’ salaries and bonuses are not paid. These and many more are reasons given by supporters and fans of a football team if their team continues to lose matches. Unsurprisingly, the only word supporters and fans of football teams are interested in is victory, victory, victory. They are heartbroken and disappointed if their team fails to win matches consistently. They lose motivation and do not show interest in watching matches played by their own favourite team.

The feeling was almost the same for most market participants when the stock market in Ghana was in its moment of ‘inactivity’ for the last three years. Almost nothing exciting was happening. Most local investors almost forgot the existence of a stock market in Ghana while most non-resident foreign (NRF) investors almost had nothing like Ghana Stock Exchange on their radar. It was a moment when all hopes were visibly beginning to be lost among market participants as some decided to leave the industry to find jobs elsewhere. Indeed, the market lost some fine, both upcoming and well experienced stockbrokers during the period. It was a moment when owners of brokerage firms who could not bear it anymore started to contemplate calling it quit due to the loss being recorded as a result of poor income being generated.

Stock markets experience moments of recession due to several factors such as high interest rates, high exchange rate fluctuations, economic and political risks among others. These factors are like natural forces that have no artificial antidote as far as the stock market is concerned. Stock markets take a long time to recover from long and persistent recessions that are caused by some of those natural compelling forces. Studies have shown that the conditions described above are not entirely new to stock markets and there is no stock market that can be immune to situations of that nature.

I remember being thought in Physics at the secondary school that ‘action and reaction are equal and opposite’. That is Isaac Newton’s third law of motion which was explained that whenever two objects interact with each other, they exert forces upon each other. For example, a fish uses its fins to push water backwards. But a push on the water will only serve to accelerate the water. Since forces result from mutual interactions, the water must also be pushing the fish forward, propelling the fish through the water. The magnitude of force on the water equals the size of force on the fish; the direction of the force on the water is opposite the direction of the force on the fish. This means that the pair of action-reaction forces makes it possible for a fish to swim. How amazing that nature has these forces that work together to produce a result in two dimensions.

The natural forces in the financial markets also work in a similar manner. These forces affect both the money market and the capital market (stock market) in different dimensions. The forces cause both markets to show natural symptoms of reaction which no artificial reaction can effectively correct. An example is a reaction of the stock markets to the movement of interest rates. The movement of interest rates in an economy shows what direction the stock market will go. A high interest rate regime is an indication of a low performing stock market environment, and a low interest rate regime works in an opposite direction for the capital market.

It is said that the stock market and money market are inversely related and that proves that there is a negative correlation between the two segments of the financial markets. This means that the stock market and money market move in opposite directions. What we should realize is that, investment is rational and profit oriented as such, demand for investment on either market is influenced by the level of anticipated returns from the market. Consequently, investment will move from the stock market to a high interest earning money market, whereas the stock market begins to attract investment when interest rates drop to a low level on the money market. The reasons for a high interest rate regime can be saved for another day. However, it is apparent that there are natural forces that influence the direction of both markets and the reaction of each market depends on the magnitude of force on the other.

Consider the following example of how powerful these forces can be. The Ghana Stock Exchange performed quite abysmally from 2014 to 2016 with negative returns for the whole three years. It  recorded -5.4% for 2014, -11.77% for 2015 and -15.33% for 2016. In those same years the Treasury Bills returned 22.51%, 23.66% and 21.05% in that order. Clearly, ‘the force’ of high interest rate managed to push the stock market performance into negative territory for three long frustrating years. I trust you remember that ‘action and reaction are equal and opposite’ and that the two markets are negatively correlated.

Gladly however, the tides have turned at this moment. While the current interest rate of Treasury Bills is around 13.55% per annum the Ghana Stock Exchange has recorded a gain of 40.40% from the beginning of 2017 to-date. Again, the forces are easing off the money market and this is allowing the stock market to flourish. It is clear that investment is happy to be moving towards the stock market. In situations such as this, demand for shares of anticipated good performing companies experience high demand. Indeed, that is when the natural forces of demand and supply also move in to cause appreciation of share prices on the stock market. Investors and stock market participants enjoy bullish moments when prices are appreciating.

Likewise, supporters of football teams say their coach is the best and they heap praises on the team if things are going well. Indeed, major changes are instituted in turning a team into a match winnable one. A team that works hard and adopts the right tactics wins matches because it is applying a stronger force against the opposing team. That force propels the team to win to the excitement of fans. This helps the supporters to regain confidence in the team – knowing that it is a formidable force.

Equally, market participants and patrons of the Ghanaian stock market are glad that some excitement has returned to the stock market. It is their hope that the natural forces will continue to suppress interest rates while propelling the stock market further so investment will continue to be happy on the stock market for a long time.

Credit: Seth Q. Ofori

Source: thebftonline.com