Some investment styles such as growth investing, value investing, and earnings momentum investing avoid macroeconomic data analysis
Each of these investment styles focuses on different aspects of a company, and thus may not be as affected by top-down economic data. For example, growth investors focus on a company’s expected future earnings growth, while value investors focus on undervalued companies with strong fundamentals. Avoiding macro data keeps things simpler for the analyst, but he may be forgetting an important factor in his model.
Macroeconomic indicators provide information about the overall health of an economy. This information can be helpful in making investment decisions, as it can give insight into whether an economy is growing or shrinking.
The most important economic indicators that can affect investment decisions are inflation, unemployment, gross domestic product (GDP), and interest rates.
1. Inflation
Inflation is a general rise in the prices of goods and services in an economy.
How Is Inflation Measured?
The Consumer Price Index (CPI) is an economic indicator that measures the average change in prices of goods and services purchased by households. It is generally a good, but imperfect measure of inflation in Canada.
It measures the average changes in prices for a basket of goods and services that are typically consumed by households. The index is compiled by Statistics Canada and is released monthly. The CPI measures the change in prices of a fixed basket of goods and services from month to month. The basket is based on expenditures by a representative sample of households and is updated periodically.
In order to be included in the CPI, a good or service must be purchased for consumption purposes (e.g., food, housing, transportation, medical care, etc.). Investment items such as stocks, bonds, and real estate are not included in the index.
The CPI is not a perfect measure of inflation, and it has some drawbacks.
First, the index only includes a limited number of goods and services, so it may not accurately reflect changes in prices for all items.
Second, the basket of goods and services included in the index is based on expenditures by a representative sample of households, so it may not necessarily reflect the spending patterns of all consumers.
How Does Inflation Impact Investment Decisions?
This affects investment decisions because investors must decide whether to buy now or wait for prices to increase. If inflation is high, it may be better to buy now and sell later when prices are higher.
Inflation can also impact investment decisions by making it difficult to predict future prices. This makes it risky to invest in certain assets, such as commodities, that may be impacted by inflation.
Finally, inflation can erode the value of investments over time. This is why it is important for investors to consider inflation when making investment decisions.
What Investments Are Protected Against Inflation?
An investor should consider inflation when making investment decisions. When inflation is high, the purchasing power of money diminishes, so an investor will want to choose investments that will offer some protection against inflation.
Real estate and commodities are two types of investments that generally offer some protection against inflation.
2. Unemployment
Unemployment is the number of people who are actively looking for work but are unable to find a job. The unemployment rate in Canada is measured by Statistics Canada through the Labour Force Survey.
How Is Unemployment Measured?
The unemployment rate is the number of unemployed people as a percentage of the labour force. The labour force is the number of people aged 15 and over who are employed or unemployed.
What Is The Historical Unemployment In Canada?
The historical unemployment rate in Canada for each of the last 4 complete decades was:
- 1980’s: 7.2%
- 1990’s: 9.0%
- 2000’s: 6.8%
- 2010’s: 8.3%
How Does Unemployment Impact Companies?
Low unemployment such as we’ve lived through in the recent past can create wage pressure. This can in turn lead to workers having more bargaining power when it comes to negotiating salaries. If there are more jobs available than there are workers, then employers may be forced to offer higher wages in order to attract and retain employees. Additionally, low unemployment can also reduce the amount of competition for jobs, which can also lead to higher wages.
Which Companies Thrive Under Wage Pressure?
Some companies that may thrive under wage pressure environments are those that are able to offer high wages in order to attract and retain workers. Additionally, companies that are able to automate their production processes or utilize technology in order to reduce labor costs may also be more successful in these types of environments.
3. GDP
Nominal GDP is the value of all goods and services produced in a country, without adjusting for inflation. Real GDP is the value of all goods and services produced in a country, after adjusting for inflation.
The phases of the economic cycle are: expansion, peak, contraction, and trough.
In an expansion, the economy grows and increases in activity. A peak is when economic growth starts to slow down and stalls. A contraction is a period of declines in economic activity, typically marked by a recession. A trough is the lowest point of the contraction phase, after which the economy starts to expand again.
The economic cycle is not always smooth. There can be periods of growth followed by sharp contractions, or vice versa. The length of each phase also varies and is difficult to predict.
How Does The Economic Cycle Impact Valuations?
First, during an expansion phase, stock prices tend to rise as more people are employed and have money to invest. This increase in demand drives up prices. Conversely, during a contraction phase, stock prices usually fall as people lose their jobs and have less money to spend.
Second, the economic cycle impacts valuation ratios such as price-to-earnings (P/E) and price-to-book (P/B). During an expansion phase, these ratios tend to rise as investors are willing to pay more for shares of companies that are growing their earnings. However, during a contraction phase, these ratios tend to fall as investors become more risk-averse and seek out cheaper stocks.
Third, the economic cycle can impact a company’s ability to generate cash flow. During an expansion phase, businesses typically have strong sales and profit growth which leads to increased cash flow. However, during a contraction phase, businesses may see declining sales and profits which results in less cash flow. This can impact a company’s ability to pay dividends or make other financial commitments.
Fourth, the economic cycle can influence a company’s borrowing costs. During an expansion phase, businesses often have strong credit ratings and can access capital at favorable interest rates. However, during a contraction phase, businesses may see their credit ratings decline which can lead to higher borrowing costs.
Finally, the economic cycle can impact consumer confidence. During an expansion phase, consumers tend to feel confident about their personal finances and are more likely to spend money. However, during a contraction phase, consumers may become more cautious with their spending as they worry about losing their jobs or seeing their investments decline in value.
How GDP Impacts Investing
An investor must be mindful of not overpaying when economic cycles are at their high, and he must be opportunistic when economic cycles are at their low. Having a contrarian helps a lot here.
4. Interest Rates
Interest rates are the percentage of interest charged on loans. Generally, the best interest rate indicator to follow is the Prime Rate, the London Interbank Offered Rate (LIBOR), and the yield on 10-year US Treasury bonds. The Bank of Canada’s benchmark overnight rate is our national version of this.
How Interest Rates Impact Companies And The Stock Market?
The interest rate is the cost of borrowing money, and it can have a big impact on investing. For example, when interest rates are low, people are more likely to borrow money to buy things like houses or cars. This can lead to increased demand for these items and drive up prices. Conversely, when interest rates rise, people are less likely to borrow money and prices may fall.
Interest rates can also impact the stock market. When rates are low, companies can borrow money more cheaply and may use this money to expand their businesses or pay dividends to shareholders. This can lead to higher stock prices. Conversely, when interest rates rise, it becomes more expensive for companies to borrow money and they may cut back on these activities, leading to lower stock prices.
How To Profit From Rising Interest Rates?
If you are looking to invest in a rising interest rate environment, consider investing in assets that have a low sensitivity to changes in interest rates. These include assets such as cash, bonds, and certain types of stocks.
Investing in assets that have a high yield also protects your money. This includes investments such as real estate, dividend-paying stocks, and high earnings yield stocks or bonds.
Lastly, you can consider investing in alternative investments such as hedge funds or commodities. These types of investments can provide diversification and protection against rising interest rates.
