#6: What really drives the stock market?

The answer will force you to rethink.

Every morning before the market opening bell at 9.15 AM, most of us get a slew of notifications title '“10 important factors that will drive the market today”. Deep down in our hearts, we know that the actual number of factors affecting the markets is much more than 10, yet we click on the notification knowing that this is perhaps our best bet towards making some sense of all the madness that drives stock prices.

The reality is, there is just one factor that determines the price of each and every stock. And if anyone can get that right, they will have reached the holy grail of stock investing as close as it gets.

Before I come to it, there’s some groundwork that needs to be discussed.

Any fairly active investor in the markets will know of many stocks which have much more intrinsic values than what they are trading at. Yet these stocks have remained at the same price year after year.

There are many companies holding great assets, which even if liquidated today, would give the shareholders a much higher return than the price at which the shares are trading. Yet these stocks keep languishing at the same price day after day, week after week.

On the flip side, many stocks have been claimed ‘overpriced’ by analysts over and over. Still, the prices keep increasing.

There are numerous instances of research-backed solid investment moves that have gone wrong - yet if you analyze them in hindsight, you are highly likely to say “I don’t think it should have been done differently”.

What then, is it, that drives the prices?

Frankly, the impact of all news, all frenzy, and even all misinformation spread on any stock boils down to this one thing - the flow of money in and out of the stock.

I often try thought experiments to get to the bottom of a concept. Here’s one for you - Imagine a very poor country with very intelligent people. These people can think on their feet and reach accurate conclusions at the speed of light. However, somehow they have no money.

This country has a stock market that offers the shares of another more ‘normal’ economy. The information is freely available. How do you think the stocks will perform in this country?

There will be numerous research reports for sure, telling why a stock should be bought or sold. But there will be no actual price movement! So all research goes down the drain.

Applying this concept to everyday market economics - if a stock frenzy can actually convert into an inflow of investor money into that stock, the prices will rise. As an investor, it is important for you to analyze where this frenzy is coming from. Say, if it is coming from teenagers or newbie stock investors, chances are it will not convert into actual buying! So it is better to stay away.

Similarly, if talking heads on news media are claiming that India's growth story is going strong and the equity markets are expected to grow like ‘never before’, you must look into who is releasing the data and who is relying on it. That will make the entire difference.

It is for the same reason the figures for FPI inflow and outflow are so important for a stock market. No matter how strong the financial results are being released, if the foreign investors are taking their money out, there is practically little that can support prevailing prices.

That also explains the reason behind the fact that during the peak of the second wave in India when almost every Indian analyst was bullish on the markets, the markets were not performing as per expectations. The FPIs were pulling money out.

As soon as the wave subsided, they brought back the money and the markets rose too.

So here’s what an investor can do with all this information - whenever any news is analyzed for the market, do not forget the last leg of this analysis - whether the impact of this news will actually drive investor decisions. If you can master this trait, there will be little that can stop you from making fortunes.

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Surbhi Singhal is a Chartered Accountant and a Company Secretary; and the founder of Advance Thinktank. The company specializes in preparing custom research reports regarding investment opportunities in India, tailored to the client's needs.