2.0 Introduction

The dynamic relationship between macroeconomic variables and share returns have been widely discussed and debated. It is an uneasy task to select a proper macroeconomic variable that could be most valuable in tracing the relationship between macroeconomic variables and stock market price. Besides, the findings of the literature suggest that there is a significant linkage between macroeconomic factors and stock return in countries examined. In this paper, we examine the stock price with the selected macroeconomic variables namely exchange rate, inflation rate, money supply, interest rate and industrial production in Malaysia. This part of literature review aims to contribute to the literature on the interaction between the stock market and macroeconomic variables.

In this paper, we hope that our findings would provide a deeper understating on the stock market behaviour in enhancing a better decision making for the government. Besides, it is important for us to know which macroeconomics variable would affect the stock market the most, investor would become more wise and able to proactively strategize their investment according to the change of the monetary policy (Rahman et al., 2009).

Classification of macroeconomic variable according to Economic indicator

An economic indicator is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance. One application of economic indicators is the study of business cycles. Nowadays a large spectrum of macroeconomic variables is regularly published to indicate various tendencies in both private and public life ( Pilinkus.D. and Boguslauskas.V., 2009).

The leading business cycle dating committee in the United States of America is the National Bureau of Economic Research. The National Bureau of Economic Research offers a classification according to the timing how macroeconomic variables change relative to the changes of the economy as a whole (Shiskin, Moore, 1968). Economic indicators can be classified into three categories according to their usual timing in relation to the business cycle: leading indicators, lagging indicators, and coincident indicators

Leading indicators

Leading indicators are indicators that usually change before the economy as a whole changes. They are therefore useful as short-term predictors of the economy. Stock market returns are a leading indicator, the stock market usually begins to decline before the economy as a whole declines and usually begins to improve before the general economy begins to recover from a slump. Besides, money supply and inflation rate is also attributing to this group of indicators.

Lagging indicators

Lagging indicators are indicators that usually change after the economy as a whole does. Typically the lag is a few quarters of a year. The unemployment rate, interest rate and exchange rate are a lagging indicator: employment tends to increase two or three quarters after an upturn in the general economy. In a performance measuring system, profit earned by a business is a lagging indicator as it reflects a historical performance; similarly, improved customer satisfaction is the result of initiatives taken in the past.

Coincident indicators

Coincident indicators change at approximately the same time as the whole economy, thereby providing information about the current state of the economy. There are many coincident economic indicators, such as Gross Domestic Product, industrial production coincident index may be used to identify, after the fact, the dates of peaks and troughs in the business cycle

As a result, Leading macroeconomic variables dominate in scientific literature since their fluctuations set signals and help predict what the economy will be like in the future. It is relevant to state that a separate macroeconomic variable is doomed to subjectivity, thus a set of macroeconomic variables is required for a more precision picture on economic developments. (Pilinkus.D. and Boguslauskas.V., 2009).

2.1 Review of the Literature

2.1.1 Inflation rate

Inflation rate acts as a proxy for consumer price index (monthly). It is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Maysami.R.C., C.H. Lee., Mohamad Atkin Hamzah. (2004), examine that the relationship between macroeconomic variables and stock market indices in Singapore pointed to a negative relation between inflation and stock prices. This result is consistent with Nadeem Sohail and Zakir Hussain (2009), Kandir. S.Y. (2008), Imran All, Kashif Ur Rehman, Ayse Kucuk Yllmaz, Muhammad Aslam Khan and Hasan (2010) which result in a rise in interest rate. Thus, this discourages investment and leads to decline in the stock prices. Besides, inflation will decrease the value of money, which ultimately effect on investments. Thus, people will tend to purchase more on durable goods, bonds, gold, foreign currency and shares, which will hedge against the inflation. ( Ahmed.R and Mustafa.K., 2000).

However, Asmy, Mohamed; Rohilina, Wisam; Hassama, Aris and Fouad, Md. (2009), for the case of Malaysia presented the result contradict with the previous researchers. The positive relationship between inflation rate and stock prices indicate that the feature of Malaysian stock prices as being good hedges against inflation.

2.1.2 Exchange rate

Exchange rate is expressed in units of the domestic currency per unit of foreign currency. Exchange rate seems to impact the stock prices positively. Imran All, Kashif Ur Rehman, Ayse Kucuk Yllmaz, Muhammad Aslam Khan and Hasan (2010) document a positive relationship between exchange rate and stock prices. This is in line with Kandir. S.Y. (2008), Nadeem Sohail and Zakir Hussain (2009), and Maysami.R.C., C.H. Lee., Mohamad Atkin Hamzah. (2004). The empirical evidence regarding the exchange rate is inconclusive.

Alsyah Abdul Rahman, Noor Zahirah Mohd Sidek and Fauziah Hanim Tafri (2009), Pilinkus.D and Boguslauskas.V (2009) investigate negative relationship between exchange rate and stock prices. The rationale behind the finding is related to the affect of exchange rate on nature of the economy. If a country is export-depending, when there is currency depreciation will lead to increase in net exports due