Effect Of Economic Factors On FTSE100 Stock Prices

It’s believed that an economic atmosphere is a major factor in determining the primary trend of a stock market. L H Beng (1998)The stock market, on the other hand, is often regarded as an effective and a reliable barometer of a country’s economy, and the stock prices are deemed as a reflection of future expectations concerning the economic well being of a country. Invariably, Stock, by its very nature, cannot be seen off as an independent entity from economic realities and performance. Consequently, it is of great interest to find out or examine the relationship between some economic variables and the pricing of stocks in the London stock exchange.

This empirical study is carried out to examine the effect of economic factors on stock price with reference to FTSE100 price index of London stock Exchange. The main objective of the study is to examine some peculiarities or differences in terms of economic variables that influence stock prices in the London stock market. The effects of retail sales index, consumer price index and industrial production index (IPI) on stock prices shall be duly examined.

The study makes use of regression model to analyze nine year (Jan. 2000 – Nov. 2009) monthly data obtained on ftse100 price index and some identified explanatory variables among other numerous variables that could be identified to determine stock prices in any economy.

LITERATURE REVIEW

Series of empirical studies have been carried out on the effect or influence of economic variables on the stock price. P I Ojeaga & V O Folajin (2009) showed in their study that stock price correlated with the price of industrial product and composite price index, also strongly related to the average naira dollar exchange, market capitalization, broad money supply and maximum lending rate in Nigeria economy.

N F Chen, R Roll & S A Ross (1986) argued that stock returns are exposed to systematic economic news, that they are priced in accordance with their exposures and that the news can be measured as innovations in state variables whose identification can be accomplished through simple and intuitive financial theory. The study was carried out with the use of efficient market theory and rational expectations inter temporal asset-pricing theory (Cox et al 1985). According to the study, industrial production and changes in risk premium have a great influence on the stock returns while index of oil price changes showed no effect on the asset pricing.

Abeyratna G, Anirut P and David M P (2004) displayed empirically in their study that there is a long run equilibrium relationship between the stock prices and the rate of inflation, the money supply and the Treasury bill rate in an emerging market of South Asia.

Mukherjee and Naka (1995) applied Johansen’s (1998) VECM to analyze the relationship between the Japanese Stock Market and exchange rate, inflation, money supply, real economic activity, long-term government bond rate, and call money rate. They concluded that a co integrating relation indeed existed and that stock prices contributed to this relation.

R C Maysami, L C Howe and M A Hamzah (2004) concluded in their research study that Singapore stock market and the SES All-S Equities Property Index formed significant relationships with all macroeconomic variables identified, while the SES All-S Equities Finance Index and SES All-S Equities Hotel Index form significant relationships only with selected variables. Specifically, for the SES All-S Equities Finance Index, real economic activity and money supply were not significant, and in the case of SES All-S Equities Hotel Index, money supply, and short- and long-term interest rates were insignificant.

Omran (2003) examined the impact of real interest rates as a key factor in the performance of the Egyptian stock market, both in terms of market activity and liquidity. The co integration analysis through error correction mechanisms (ECM) indicated significant long-run and short-run relationships between the variables, implying that real interest rates had an impact upon stock market performance.

Maysami and Koh(2000) studied and found out that inflation, money supply growth, changes in short- and long-term interest rate and variations in exchange rate formed a co-integrating relation with changes in Singapore’s stock market levels.

As revealed above, two variables (index of industrial production and consumer price index) out three highlighted variables have been tested by earlier researchers and the results showed a clear relationship with stock prices. In this study, the variables will be retested along side with retail sales index vis-a-viz London stock exchange.

ABOUT THE LONDON STOCK EXCHANGE

The London Stock exchange is the most important exchange in Europe and one of the largest in the world. It lists over 3000 Companies and with 350 of the companies coming from 50 different countries, the LSE is the most international of all exchanges.

The London stock exchange is comprised of two different stock markets: the main market and the alternative investment market (AIM). The main market is solely for established companies with high performance, and the listing requirements are strict. Approximately 1,800 of the LSE’s company listings trade on the main market, and the total market capitalization of 37 Billion.

The LSE is completely electronic, but different shares are traded on different systems. Highly liquid shares are traded using SETS automated system on an order driven basis. This means that when a buy and sell price match, an order is automatically executed. For securities that trade less regularly, the London stock exchange implements the SEAQ system, where market makers keep the shares liquid. These market makers keep are required to hold shares of a specific company and set the bid and ask prices, ensuring that there is market for the stock.

The LSE also has a new and growing exchange for equity derivatives called EDX London, created in 2003. In 2004, EDX traded an average of 382,599 contracts per day. It aim is to become the leading derivative market in the world (see http://www.advfn/stockexchanges/about/LSE/LondonStockExchange.html)

STOCK MARKET

A stock market is a public market for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those on traded privately.

The size of the world market was estimated at about $36.6 trillion US at the beginning of October 2008. The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organisation specialized in the business of bringing buyers and sellers of the organisation securities together. The stock market in the United States is NYSE while in Canada; it is the Toronto stock exchange. Major European examples of stock exchanges include London Stock Exchange, Paris Bourse, and the Deutche Borse. Asian examples include the Tokyo stock exchange, the Hong kong stock exchange, and Bombay stock exchange. In Latin America, there are such exchanges as the BM&F Bovespa and BMV (see http//en.wikipedia.org/wiki/stock_market).

SECURITIES

A security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized into debt security (such as banknotes, bonds and debentures) and equity securities, e.g., common stocks; and derivative contracts, such as forwards, futures, options and swaps. The company or other entity issuing the security is called the issuer (see http://en.wikipedia.org/wiki/security_(finance)).

STOCK MARKET INDEX

The movement of the prices in a market or sections of a market are captured in price indices called stock market indices of which there many, e.g. S & P, the FTSE and the Euronext indices. Such indices are usually market capitalization weighted, with the weights reflecting the contribution of the stock to the index. The constituents of the index are reviewed frequently to include / exclude stocks in order to reflect the changing business environment (see http://en.wikipedia.org/wiki/stock_market).

FTSE 100 INDEX