First of all, it has to be acknowledge that most firms stock success is tied to those of the broader economy.
For the ones whose stock is really sensitive to the economy, you have to know where the economy is heading otherwise you might be holding to a stock that is about to get hit.
So in order to start investing you have to examine the state of the economy and the implications of the outside environment on the industry in which the firm operates.
Moreover the firm’s position within the industry. To earn profits you have to forecast it better than your competition.
Enough said, lets get started!
The Economy
Key words to know:
GDP:
This is the most important indicator of the state of the economy. It measures the total production of goods and services a country made in a year or every quarter. The growth of the economy is measured by the increase in real GDP. Usually, the figure that appears in the financial press is the nominal GDP, so you have to subtract the inflation from it. What you really have to know is that recession is said to occur when real GDP has declined for at least two consecutive quarters.
Inflation:
Is the rate at which the price of goods increase annually. This indicator is directly linked to the supply and demand for your currency
Interest rates:
Demand for housing or for example cars is really sensitive to interest rates so it makes it an important indicator. Moreover it a tool government uses to control demand in order to keep inflation at a reasonable rate.
Unemployment rate:
This is the percentage of the total labour force who are either working or actively seeking employment
Manufacturers’ new orders:
Which means that demand is increasing, so they need to increase inventory
Building permits:
In the commercial side it means that businesses are expanding and in the residential side it means that consumers are better-off since they now have enough revenue to buy a house
Those are the main indicators, there are many more but with this you’ll have a good start and be able to understand what read on newspapers on the economy.
The business cycle:
The business cycle can be defined as Fluctuations in production and employment that shape the business cycle and directly affect the value of investments over time. It has different phases, there is expansion, trough, peak, and contraction. It has an effect on almost all sectors. They are recurrent but they do not have the same intensity or duration. An interesting insight to know is that they typically last between 1 and 12 years.
Now, how can we use the indicators that we learned earlier to know on which phase we are and where we going.
Expansion:
- GDP accelerates
- The unemployment rate falls
- The inflation picks up
- Orders increases
- Construction increases
Trough
- GDP gets back up
- Inflation slow downs
- Interest rates lowers
- There is an upturn in housing
Peak
- GDP growth rate decelerates
- Unemployment falls
- Interest rate increases
- Inflation accelerates
Contraction
- GDP growth rate declines
- Unemployment rate rises
- Decrease in manufacturer orders
- Inflation decelerate
Here you have it, if you know in which phase you are, you’ll have a better idea of which stock to hold or not to hold. And once you have made your portfolio, keeping track of the economy will help you decide which stock to hold or which one to sell. Before letting you go I have two little tips for you in order to make your life a little easier:
- If you want to remove yourself the burden of following the economy, you can buy defensive stocks, these are stocks that are less sensitive to the state of the economy. For example food producers and pharmaceutical firms
- How can you keep yourself informed easily? In every bank website there is a section where they post periodically information about the state of the economy. I suggest getting the opinion of 2-3 of them before deciding which course to follow.