What Makes the Stock Market Fluctuate?

In reality, the stock market is a mechanism that prices in the current value of future earnings, and these valuations fluctuate according to several interrelated factors.

Changes in Earnings

The purpose of any publicly traded corporation is to generate earnings. Each quarter, companies announce earnings, and the share price fluctuates based on whether the performance met, exceeded or fell short of expectations.

Multiple Contraction/Expansion

To value a company's future earnings, analysts apply a multiple based on numerous factors. As these conditions change, this price to earnings multiple will expand or contract, causing the share price to fluctuate even if earnings remain constant.

Availability of Credit

Investors need available credit to fund their stock purchases, and sustain high price to earnings multiples. Consumers who cannot get credit easily will consume less, forcing companies to cut costs and produce less to maintain their accustomed level of earnings.

Sentiment

Expectations about the economy color how investors see individual stocks and interpret news. But sentiment is often reinforcing, with investors reacting to positive action with more enthusiasm and vice versa. Markets tend to overshoot irrationally, evidence that a good bit of stock fluctuation is driven by raw emotion.

Interest Rates

Low interest rates amount to cheap credit, and tend to fuel economic expansion and optimism. As interest rates rise, cash and fixed income assets become more competitive, and drive investment away from stocks.

References

• http://www.buzzle.com/editorials/7-7-2006-101553.asp
• http://www.area219.com/finance/investing/86/Understanding-What-Makes-The-Stock-Market-Move-Up-And-Down.htm

Resources

• Price-Earnings Ratio
• Why does the stock market fluctuate?
• MoneySpeak: The Fluctuating Stock Market