4 Factors That Shape Market Trends – Investopedia
Trends are what allow traders and investors to capture profits. Whether on a short- or long-term time frame, in an overall trending market or a range of environment, the flow from one price to another is what creates profits and losses. There are four major factors that cause both long-term trends and short-term fluctuations. These factors are government, international transactions, speculation and expectation and supply and demand.
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Major Market Forces
Learning how these major factors shape trends over the long term can provide insight into how future trends may occur. Here are the four major factors:
GovernmentGovernment holds much sway over the free markets. The fiscal and monetary policies that governments and their central banks put in place have a profound effect on the financial marketplace. By increasing and decreasing interest rates, the U. S. Federal Reserve can effectively slow or attempt to speed up growth within the country. This is called monetary policy. If government spending increases or contracts, this is known as fiscal policy and can be used to help ease unemployment and/or stabilize prices. By altering interest rates and the amount of dollars available on the open market, governments can change how much investment flows into and out of the country. (Learn more in our Federal Reserve System tutorial. )
International TransactionsThe flow of funds between countries effects the strength of a country’s economy and its currency. The more money that is leaving a country, the weaker the country’s economy and currency. Countries that predominantly export, whether physical goods or services, are continually bringing money into their countries. This money can then be reinvested and can stimulate the financial markets within those countries.
Speculation and ExpectationSpeculation and expectation are integral parts of the financial system. Consumers, investors and politicians all hold different views about where they think the economy will go in the future and that effects how they act today. Expectation of future action is dependent on current acts and shapes both current and future trends. Sentiment indicators are commonly used to gauge how certain groups are feeling about the current economy. Analysis of these indicators as well as other forms of fundamental and technical analysis can create a bias or expectation of future price rates and trend direction.
Supply and DemandSupply and demand for products, services, currencies and other investments creates a push-pull dynamic in prices. Prices and rates change as supply or demand changes. If something is in demand and supply begins to shrink, prices will rise. If supply increases beyond current demand, prices will fall. If supply is relatively stable, prices can fluctuate higher and lower as demand increases or decreases.
These factors can cause both short- and long-term fluctuations in the market, but it is also important to understand how all these elements come together to create trends. While all of these major factors are categorically different, they are closely linked to one another. Government mandates can effect international transactions, which play a role in speculation and changes in supply and demand can play a role in each of these other factors.
4 Factors That Shape Market Trends
Government news releases, such as proposed changes in spending or tax policy, as well as Federal Reserve decisions to change or maintain interest rates can also have a dramatic effect on long term trends. The lowering of interest rates and taxes can encourage spending and economic growth. This in turn has a tendency to push market prices higher. However, the market does not always respond in this way because other factors may also be at play. Higher interest rates and taxes, for example, can deter spending and result in a contraction or a long-term fall in market prices.
In the short term, these news releases can cause large price swings as traders and investors buy and sell in response to the information. Increased action around these announcements can create short-term trends, while longer term trends may develop as investors fully grasp and absorb what the impact of the information means for the markets.
The International Effect
International transactions, balance of payments between countries and economic strength are harder to gauge on a daily basis, but they also play a major role in longer-term trends in many markets. The currency markets are a gauge of how well one country’s currency and economy is doing relative to others. A high demand for a currency means that currency will rise relative to other currencies.
The value of a country’s currency can also plays a role in how other markets will do within that country. If a country’s currency is weak, this will deter investment into that country, as potential profits will be eroded by the weak currency.
The Participant Effect
The analysis and resultant positions taken by traders and investors based on the information they receive about government policy and international transactions create speculation as to where prices will move. When enough people agree on one direction, the market enters into a trend that could sustain itself for many years.
Trends are also perpetuated by market participants who were wrong in their analysis. When they are forced to exit their losing trades, it pushes prices further in the current direction. As more investors climb aboard to profit from a trend, the market becomes saturated and the trend reverses, at least temporarily.
The Supply & Demand Effect
Supply and demand effects individuals, companies, and the financial markets as a whole. In some markets, such as commodities, supply is determined by a physical product. Supply and demand for oil is constantly changing, adjusting the price a market participant is willing to pay for oil today and in the future.
As supply dwindles or demand increases, a long-term rise in oil prices can occur as market participants outbid one another to attain a seemingly finite supply of the commodity. Suppliers want a higher price for what they have and higher demand pushes the price that buyers are willing to pay.
The financial markets have a similar dynamic. Stocks fluctuate on a short and long-term scale, creating trends. The threat of supply drying up at current prices forces buyers to buy at higher and higher prices, creating large price increases. If a large group of sellers were to enter the market, this would increase the supply of stock available and would likely push prices lower. This occurs on all time frames.
The Bottom Line
As stated above, trends are generally created by four major factors: government, international transactions, speculation/expectation and supply and demand. These areas are all linked as expected future conditions shape current decisions and those current decisions shape current trends. Government effects trends mainly through monetary and fiscal policy. These policies effect international transactions which in turn effect economic strength. Speculation and expectation drive prices based on what future prices might be. Finally, changes in supply and demand create trends as market participants fight for the best price.
Follow the trend: US demand is back, supply is lagging, but …
By April 2021 robust consumer spending and strong investment by businesses and homebuilders in the United States had driven total demand nearly back to its pre-pandemic trend. At the same time, employment was about 7 percent below its trend (or 10 million workers short). Even though hours and productivity of employed workers were up, that was still not enough to enable the United States to produce as much as the economy was demanding, with the difference made up by increases in net imports and reductions in inventories.
April 2021 was an eternity ago in COVID-19 time: Cases were rising in the United States through mid-April and deaths were plateauing. Since their April highs, cases have fallen by 70 percent and deaths by 40 percent.
Since April, both demand and supply have likely increased at a rapid pace. Services consumption appears to have been rising rapidly as the economy has reopened, and substantial additional jobs were likely added since April as well. The key question going forward is whether demand or supply returns more quickly and the consequences of any mismatch between the two. Understanding the economy’s recent past can help inform near-term predictions about the economy and also identify key factors to watch as the economy continues to normalize as the pandemic recedes. The most hopeful, and possibly most plausible, scenario is that demand can create supply, thus enabling the economy to end up in a stronger position than the pre-pandemic trend it was on. The path to this favorable outcome is bumpy and uncertain—with other paths possible as well.
Demand is back
To understand what is going on in the US economy right now, it is useful to adopt a specific definition of total demand in the economy as the amount that domestic purchasers (households, businesses, and government) buy in the form of items like cars, cereal, meals, machines, new houses, tanks, and educational services. In the national accounts it is technically called “Final Sales to Domestic Purchasers” and is defined as:
Demand (aka Final Sales to Domestic Purchasers) = Consumption + Business Fixed Investment + Residential Investment + Government Purchases
Consumer spending comprises about two-thirds of demand. In April monthly household expenditure was 1 percent below its pre-pandemic trend (figure 1). (For all charts, unless otherwise noted, the pre-pandemic trend is based on fitting data from 2018 and 2019 with a log-linear regression. )
The overall numbers for consumer spending concealed considerable variation. Spending on goods was 11 percent above its pre-pandemic trend, an unprecedented increase seen in everything from cars to furniture to recreational goods (figure 2, panel a). At the same time, spending on services was 7 percent below its pre-pandemic trend, as restaurants, travel, and healthcare remained depressed by the pandemic (figure 2, panel b).
These data are for the average US consumer. Evidence from Opportunity Insights and other sources suggest that consumption has grown faster for lower-income households, which have benefited from significant government transfers and have lower COVID-sensitive services spending. It is plausible that spending was above the pre-pandemic trend for lower-income households and that the entire shortfall in consumer spending was because spending has not returned for high-income households.
In some other categories, demand was above pre-pandemic trends, likely including new residential investment (fueled by low mortgage rates and strong consumer incomes) and possibly also business investment in plants and equipment (although it is a lumpy category that is not measured at a monthly frequency) (figure 3).
The US government does not measure overall demand at a monthly frequency. The best estimates, which are produced by IHS Markit, indicate that demand in the form of final sales to domestic purchasers was just 0. 4 percent short of its pre-pandemic trend in April.
Supply is lagging
Although US residents were purchasing just as much as they were before the pandemic (adjusted for trends), they were not producing nearly as much. This can be understood by looking at the supply side of the economy, which can be formalized as:
Supply (technically Gross Domestic Product) = Total Hours Worked * Output Per Hour (aka Productivity)
Overall GDP was about 2 percent below the pre-pandemic trend in April, according to estimates produced by IHS Markit (the government does not produce monthly GDP). There is considerable uncertainty around these numbers, but based on the official government data for the first quarter of 2021 and monthly data on major components of GDP like personal consumption expenditures, this estimate is a reasonable guess (figure 4).
Importantly, this GDP was produced by less labor than prior to the pandemic. In April, aggregate weekly hours worked by US residents in private industry were 5 percent below the pre-pandemic trend (figure 5). This was mostly because employment was 7 percent below trend (or 10 million workers short), while hours for those employed had increased.
The fact that GDP (2 percent below the pre-pandemic trend) was down by less than hours worked (5 percent below trend) implies that the average amount produced per hour—labor productivity—was up dramatically relative to its pre-pandemic trend, possibly by about 3 percent—an amount that would normally take two years to achieve. In part this increase reflected the changing composition of workers: Unemployed workers appeared to be on average less productive than the average worker, largely reflecting the fact that about one-third of job losses have been in the relatively low-productivity leisure and hospitality sector. A substantial portion of the productivity increase appears to be due to greater work intensity and technological and process changes.
One of the major sources of lagging supply was likely that workers have not returned to jobs as quickly as employers have opened up new jobs. Job openings likely soared to nearly 9 million by the end of April, bringing the job openings rate to a record nearly 6 percent based on extending official government data for March through April using data from the Indeed Hiring Lab (figure 6). The biggest reasons workers did not return to jobs were likely the continued extent of the pandemic and the fact that it takes time to match workers to jobs. In addition, the availability and magnitude of unemployment insurance have enabled more workers to take their time to find the best jobs for them or negotiate better wages or just reduce their work intensity.
In addition, supply has been constrained by supply chain bottlenecks in areas like microchips, which have affected the production of goods throughout the economy. In other areas, such as lumber and steel, production cuts at the start of the pandemic have left producers unable to keep up with the rapid recovery in demand.
Bridging the gap between supply and demand: Imports and inventories
Under the definition we are using, demand does not need to equal supply because imports and inventories can be used to satisfy the purchases of US residents without commensurate US production. Using the national accounting framework, this can be written as the identity:
Demand – Supply = (Imports – Exports) + Decrease in Inventories
Global trade collapsed during the pandemic, with both exports and imports falling. US exports and imports have since recovered, but imports have increased much more than exports (figure 7). As a result the US trade balance in goods in April was about $25 billion worse than its pre-pandemic value, an amount equal to about 1 percent of GDP. The increase in imports fills a reasonable fraction of the gap between supply and demand. (Note only the trade balance for goods is currently available for April; the full trade balance including services will be released later. )
The other way that US residents can buy things that are not produced contemporaneously is by running down inventories. Overall, prior to the pandemic, retail inventories were $655 billion and had fallen to $603 billion in the April data. As a result the ratio of inventories to sales reached its lowest level on record in March (figure 8) and likely fell further in April.
Key questions going forward: How and when demand and supply rise
Demand and supply have almost certainly continued to increase since April. It is likely that services consumption, which typically represents about half of demand, has and will continue to increase rapidly as households generally have healthy bank balances, some continued transfers from the government, and rapidly increasing labor earnings. If services consumption returned to its pre-pandemic trend without any changes in other components of demand (except a corresponding reduction in purchases of food at home), that would mean demand would be about 2 percent above its pre-pandemic trend.
The five key questions going forward are:
How much does demand rise above its pre-pandemic trend? Demand was already nearly at its pre-pandemic trend in April, and all signs indicate that it will continue to rise rapidly, greatly exceeding its pre-pandemic trend. All of the ingredients are present to support demand: a rapidly receding virus, substantial excess savings, large fiscal transfers, and rapid wage gains. If services consumption returns to its pre-pandemic trend, that would put overall demand above its pre-pandemic trend.
How much more room is there for imports and inventory reductions to support demand? Imports could rise by a substantial amount over the next months and years. Inventories cannot go negative but could be even more lean. Both of these, however, largely can support increased goods consumption but will not be able to relieve the pressure on increased services consumption unless labor and capital can shift rapidly from goods to services; after all, restaurant meals cannot be imported or taken out of inventories.
How much and how quickly does employment rise? Employment is likely to rise rapidly in the coming months as the pandemic recedes and states, and eventually the entire country, drop enhanced unemployment insurance benefits. Almost no forecasts, however, project US employment to get back to pre-pandemic trends by the end of 2021, and most forecasters expect elevated unemployment rates through much of 2022.
Can productivity stay well above its pre-pandemic trend? Measured productivity growth will face a substantial headwind as lower-productivity workers are rehired, dragging down average productivity levels. Nevertheless, at least some of the increase in productivity appears unrelated to these compositional issues. Will this growth continue? Expand? This productivity growth could be important to accommodate the additional demand even if employment does not fully return rapidly.
How much do imbalances between supply and demand place upward pressure on prices? Imbalances between supply and demand could be reconciled with higher prices, in other words, inflation. The economy experienced a large increase in price levels in April, on average making up for all of the shortfalls during the pandemic, so core consumer prices are now back at the 2 percent pace from their pre-pandemic levels (figure 9).
The most hopeful, and possibly the most plausible, case is that the demand side of the economy returns further and faster than the supply side but that demand creates supply, and rising real wages eventually draw workers in—including many who were sidelined by the pandemic or even by the arguably sub-par labor force participation prior to the pandemic. In the interim there would be more price inflation, but over time it would be offset by an economy that returns to something that could even be better than its pre-pandemic path. The most important policy at this point is patience, but policymakers should also do everything they can to increase the supply side of the economy and ensure the demand side does not get too far in front of it.
Evaluating the Importance of Demand Analysis | Infiniti Research
What is demand analysis?
Demand analysis involves understanding the customer demand for a product or service in a particular market. Companies use demand analysis techniques to determine if they can successfully enter a market and generate expected profits to advance their business operations. It also gives a better understanding of the high-demand markets for the company’s offerings, giving them a fair idea on which markets to invest in. Demand analysis is one of the most important considerations for a variety of business decisions including sales forecasting, pricing products/services, marketing and advertisement spending, manufacturing decisions, and expansion planning.
Identifying market opportunities and meeting the market demand can prove to be challenging without appropriate expertise. Request a free brochure to learn how experts at Infiniti Research can assist you with smart solutions that cater to dynamic business needs.
Key factors affecting demand analysis
Common steps in market demand analysis
While there may be several methods of market demand analysis that varies according to the complexity of operations in the business, we have curated some of the commonly used steps for demand analysis:
Market identification
Identifying the specific and target market for the company’s products or services is one of the first market demand analysis steps. Surveys or customer feedbacks can be used to determine the current customer satisfaction levels. Comments indicating dissatisfaction can lead to improvements that will eventually enhance customer satisfaction. Although companies usually identify markets close to their current product line, new industries may be tested for business expansion possibilities.
Business cycle
After identifying the potential markets, the next step is to assess the stage of the business cycle in which that particular market is. A business cycle ideally comprises of three stages: emerging, plateau and declining. Markets that are in the emerging stage indicate higher consumer demand and low supply of current products or services. The plateau stage depicts the break-even level of the market, where the supply of goods meets the current market demand. A declining stage indicates lagging consumer demand for the company’s goods or services.
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Product Niche
Once the market and their respective business cycles have been reviewed, companies will need to develop products or tailor their services to meet a specific niche in the market. Products must be differentiated from other peers in the market, so that they meet a specific need of consumer demand, creating higher demand for their product or service. It is also advisable to conduct tests in sample markets to determine which of the potential product styles is most preferred by consumers. Companies can also develop their goods in order to prevent competitors from easily duplicating their products or business strategies.
Evaluate competition
A crucial factor of demand analysis is determining the number of competitors in the market and their current market share. Markets in the emerging stage of the business cycle tend to have fewer competitors. This translates to a higher profit margin for your company. Once a market becomes saturated with competing companies and products, fewer profits are achieved and companies will begin to lose money. As markets enter the declining business cycle, companies must conduct a new market demand analysis to find more profitable markets.
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Frequently Asked Questions about demand trend
Is supply and demand a trend?
Follow the trend: US demand is back, supply is lagging, but both are likely to grow in coming months. By April 2021 robust consumer spending and strong investment by businesses and homebuilders in the United States had driven total demand nearly back to its pre-pandemic trend.Jun 2, 2021
What is a demand analysis?
Demand analysis involves understanding the customer demand for a product or service in a particular market. Companies use demand analysis techniques to determine if they can successfully enter a market and generate expected profits to advance their business operations.Apr 11, 2019
How do you identify market trends?
A common way to identify trends is using trendlines, which connect a series of highs (downtrend) or lows (uptrend). Uptrends connect a series of higher lows, creating a support level for future price movements. Downtrends connect a series of lower highs, creating a resistance level for future price movements.