In business news, we frequently read that stock markets (when we mentioned stock market, we are referring to stock indices) moved >1% a day due to news, incidents, optimism, pessimism etc. The journalists, the authors of news reports or even the wall street bankers will try to 'justify' the movement is due to certain events. You see I use the word "justify" here but not report. The reality is most of us don't know why markets behaved in certain way and certain time but there is only one big logical explanation for it - "sentiment". Of course there are other causes like fundamentals but all these will affect the sentiment that will eventually move the stock price.
Sentiment that moves Stocks
Stocks or Shares are merely "security that represents the ownership of a company". Whenever we buy or sell a stock or share, it simply means that you add on or reduce your 'ownership' of a company. Like what Warren Buffett has mentioned through his Value Investing principle: "Price is what you pay and value is what you get", the intrinsic value of a company don't change day-to-day, not unless there is a major event (i.e. a breakthrough in technology, product development). However, you will occasionally see big swings in stock prices although there is no material development in the fundamental of the companies.
Let's explore how sentiments move stock prices.
1. A positive sentiment will sway the human minds to think that the future of a company or economy is going to be better, hence the investors or traders will think that the future value of a company will increase due to better sales, better profitability. Hence, they are willing to pay more now to get into "position" or "own" the company shares. This will drive up the prices of the stocks as "buyers are more than sellers and sellers can command a better price due to the surge in demand".
2. A negative sentiment will tell the human minds to react in a way to think that there is higher risks ahead, worse days or future that lies ahead for companies and economies. Hence, the reaction will be "I will sell now so that I won't be caught if the gloomy projections does materializes". This causes more people to try to exit a stock even though they are unable to fetch the price they wanted. Hence, a reduction in stock prices is expected.
Based on the above scenarios of the positive and negative sentiments, we can further explore what causes the sentiments to change:
1. News flow (be it fake or real news)
2. Fundamental change (i.e. a company had a breakthrough in a drug trial, better quarterly profit achieved)
3. Macro economy changes - it's expected that if the economy is doing well, most of the companies will do better and vice-versa.
4. Expectation of a significant event or future - for example, the market anticipate Year 2021 to be a recovery year and COVID19 vaccine will assist to clear out the virus risks and reopen economies again. This "expectation" has drive up stock prices worldwide although we have not seen any real successes in any single country by using vaccine to wipe out COVID19 infection risks.
5. Political influence change - as our world relies on the Politicians to make decisions and policies, which will affect businesses dearly, any change in political scenario will cause the sentiment on stock markets to change.
6. Mood - when I say mood here, it's the mood of a group of people or within a region or country. Mood can be affected by many things, including employment, weather, season (i.e. winter, holiday, summer) and profitability from businesses or employment.
7. Natural disasters - the way natural disasters connected to sentiment is always negative (although some companies or countries might benefit from it - i.e. Petronas got a very good deal supplying LNG to Japan post Tsunami that caused Fukushima Nuclear plant to shut and caused a power crisis in Japan. The hike in LNG demand and prices helped many O&G companies operating off Sarawak waters as Sarawak is the biggest LNG producer in the SEA region).
8. Views from Expert, Journalist, Analysts - as surprising as it is, Bloomberg, TheEdge, FT, Morgan Stanley etc reports and views on economies and companies does have an impact that forms view points and it's very much correlated to Point 4 (Expectation). An article from a renowned analyst will definitely swing stock prices but I would argue that the views from each individual analyst only forms a piece of the "Expectation". In order for the reports or views to significantly change the sentiment, it must have the "general consensus" of public.
9. Herd mentality - Humans don't live alone and we are social animals. Sentiments are also affected by herd mentality where a group of people thinking similarly will change the views on certain things. Of course this is normally temporary and will be 'corrected' by fundamentals later on.
From the above, we know that we are unable to control the causes to the change of sentiments and definitely unable to change sentiments as it highly correlates to a "group of majority" of how people think. So how do we benefit from sentiments in stock markets? I will write more on this topic so do stay tuned.
