5 Ways Government Policies Influence Stock Market

5 Ways Government Policies Influence Stock Market

Government policies shape the environment in which businesses operate. Policies made by the government have a direct and indirect effect on the stock market. From subsidies, taxes to labor laws; the catalytic effect of these policies hardly goes unnoticed. Often, anticipated changes in policies have a weak effect on security prices. However, if the change is unforeseen, it triggers adverse effects resulting in profits or losses. 

As an investor, it makes sense to familiarize yourself with some of these outcomes from the state policies. This will help you make an informed trading decision, thereby protecting your investment. Here are some of the effects of policies on the stock market.

Interest Rates Changes 

When the government reduces interest rates, consumers and businesses increase their spending. This causes an upward trend in financial markets, resulting in increased returns. Unfortunately, the resultant increase in stock prices can swiftly take a toll on the market. This is evident from the influx of investors further increasing the prices of a stock. At this point, no one will be willing to buy at an elevated price. This causes a massive sell-off and the market hits its lowest point. 

On the other hand, when the interest rates are rising, consumers will cut back on spending. This causes a dip in the stock market as well as low earnings. 

Currency Inflation 

At times, the government may inflate the currency to encourage overseas investment. Inflation provides a short-term economic boost as evident from the increased share prices. In the long run, the value of the stocks is eroded causing most of them to reduce in price. To debtors, the reduced value in both currency and stock price provides an ideal opportunity to settle their debts. They will pay less to clear debt which further devalues financial institution stocks. 

Nonetheless, buying dividend-yielding stocks provides a partial hedge against inflation. This is because these stocks do not keep up with inflation levels, earning you constant return value. 

Also, when inflation is rising, you may consider it as an affordable entry point to dividend-yielding stocks. 

Tax incentives and Regulations

To cultivate the growth of certain companies, the government may offer tax incentives based on a certain threshold. For instance, the government may exempt taxes on stocks that gained more than 10% in the previous financial year. While this may translate to increased returns for shareholders in such companies, the small-cap stocks end up bearing the heavy taxes. 

As such, the small stocks are squeezed out of the market resulting in losses for the investors. 

Similarly, strict government regulation can push both small and large-cap stocks out of the market. For instance, the ever-increasing safety regulations imposed on manufacturing companies increase the cost of production. This disrupts the financial stability of these companies and some eventually fall out of the market. 

Bailouts

A government bailout may not have a huge impact on the overall stock market since it is granted to an individual company. However, it is hard to overlook its impact on the shareholders of the bailed-out company. 

Often, the government bails out a company that is on the verge of bankruptcy. This means that the company’s stock cost way less than what shareholders originally paid. Moreover, the company is mandated to begin repayment of the bailout loan as soon as it is operational. This forces the company to cut its dividend payments further lowering the stock price. 

Subsidies and Tariffs

The government may offer a subsidy to a chosen industry to make it profitable. In most cases, the subsidy grant is gotten from the taxes which results in a noticeable increase in tax rates. 

The increased rates prompt investors to cut down their investment efforts, resulting in a downturn market. In the case of tariffs, the government imposes taxes on foreign goods. This incentivizes domestic supplies to charge more for similar goods, causing inflation. With the rising inflation, most stocks start losing value and the entire market is set on a downturn trend. 

Summary

Legislative policies are one of the major risks investors face as they evaluate stocks. As such, a promising investment can turn out to be risky if the government of the day is not taken into consideration. 

Image sources

• https://images.pexels.com/photos/937524/pexels-photo-937524.jpeg

• https://images.pexels.com/photos/1028726/pexels-photo-1028726.jpeg

• https://images.pexels.com/photos/268466/pexels-photo-268466.jpeg