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Economic influences on investment markets (Factors affecting the supply of…
Economic influences on investment markets
The general level of the market of an asset class is determined by supply and demand
factors affecting demand
Investors' expectations for the level of returns on an asset class
Investors' expectations for the riskiness of returns on an asset class
Economic influences on short-term interest rates
Low interest rates -> increased consumer and investment spending -> economic growth
low interest rates -> increased demand for money, which may be met by increased money supply -> higher inflation
Low interest rates relative to other countries -> less investment from international investors _> depreciation of domestic currency
Economic influences on short-term government bond yields
closely related to short-term interest rates because short-term gov bonds and money market instruments are close substitutes
Economic influences on long-term government bond yields
Supply
the government's fiscal deficit and funding policy.
demand
expectations of future short-term real interest rates
expectations of inflation
the inflation risk premium
the exchange rate, which affects overseas demand
institutional cashflow, liabilities and investment policy
returns on alternative investments
other economic factors (e.g. tax, political climate)
factors affecting the yield gap between gov and corp bonds
differences in security
differences in marketability and liquidity
the relative supply of and demand for government and corporate bonds
Economic influences on the equity market
supply
relative attractiveness of debt and equity financing
rights issues, buy-backs, privatisations
demand
expectations of real economic growth
expectations of real interest rates and inflation
expectations of the equity risk premium
the exchange rate, which affects overseas demand
institutional cashflow, liabilities and investment policy
returns on alternative investments
other economic factors (e.g. tax, political climate)
Impact of inflation on equity prices
Inflation high -> higher dividend growth and required return expected -> equity markets should be relatively indifferent to inflation
Indirect effects
High inflation often associated with high interest rates -> unfavourable for economic growth-> reduce equity prices
Expectations of high inflation -> government may rise real interest rates -> reduce equity prices
High inflation -> greater uncertainty over inflation-> investors may increase their demand for real assets -> increase in equity prices
Economic influences and the property market
occupation market
expectations of real economic growth
buoyancy of trading conditions
employment levels
expectations of real interest rates
Structural changes (e.g. a move to out of town working)
development cycles
investment market
occupancy market
inflation (infrequent rent reviews could lead to inflation eroding rental value)
real interest rates
institutional cashflow, liabilities and investment policy
demand from public/ private property companies
the exchange rate (affects overseas demand)
returns on alternative investments
other economic factors (e.g. tax, political climate)
Factors affecting the supply of property
Development time (gaining consent and construction)- up to 5 years long
Economic growth- peak of the property development cycle lags behind peak of the business cycle, often resulting in a glut of new property as the economy slows down
Real interest rates- affect cost of borrowing in order to develop property
Statutory control- local planning authorities may frequently restrict development
Fixity of location, high transition costs and segmented markets