Understanding economic indicators for investment
With investment highs and lows, the best way to protect your finances is to make well-informed decisions. Get yourself started by knowing what to look out for.
Talking about the investment market and the economy can be daunting for any first-time investor. But it does not need to be. Understanding how the economy works in tandem with the market is a valuable skill that any interested investor can develop and cultivate.
First, we need to start by understanding what investing means. Investopedia.com defines investing as the act of allocating your resources, usually money, into assets or endeavors that you expect will generate income or profit for you in the future. But the basic idea is that rather than you working for your money, investing lets your money work for you.
How hard you want your money to work for you then becomes the next question. Just like everything else in life, the higher the expected reward, the greater the risk you’ll likely have to take. When it comes to investments, a lot of things can go wrong, and the best way to protect yourself from things going wrong is to do your homework. You need to understand what you plan to own and the risks associated with owning them.
The value of investments reflects many things, foremost among them being the economy, or more specifically, the outlook of the economy. What’s happening now has made this more important than ever.
The current COVID-19 pandemic and the negative impact it has had on our economy is a living, breathing, and sadly, still an ongoing example of things going very wrong. The pandemic forced an unprecedented nationwide lockdown for 75 days in the country, ceasing any form of normal social activity, like going to school or seeing friends and family, and in turn grinding the economy to a halt. This meant lost income for many businesses and companies, leading to permanent business closures and job losses. This abrupt slowdown in the economy resulted in a sharp fall in the value of assets held by investors, particularly the stock market, which fell as much as -40% in a matter of days.
While no one really could have anticipated a shock like this, we can and should use this experience to develop a better understanding and appreciation of the economy’s impact on investments. We saw first-hand that when the outlook for the economy turned bad, the value of investment assets fell. It stands to reason therefore that when the economy stabilizes and begins showing signs of recovery, the value of assets should then rise.
Important economic indicators
Understanding the health and outlook of the economy is therefore a vital part of any investment decision-making process. Studying three of the most important “economic indicators”, namely the country’s Gross Domestic Product (GDP), inflation, and unemployment, would be a good start. Looking at these economic indicators will tell you the general state of the economy at that point in time while tracking changes in these indicators over different periods will help you identify “economic trends”, and in turn, the overall direction and outlook of the economy.
GDP, or the total monetary value of all goods and services produced in a country within a specific period, is the most commonly-used measure of the size of the economy. Positive growth is therefore good, while negative growth, or GDP contraction, is not. Because of the health crisis, the Philippines’ economy is set to experience economic contraction for the first time in 22 years.
INFLATION is the increase in the average prices of a fixed basket of basic goods and services in an economy. Rising prices of goods might be viewed as a bad thing, but some inflation in the economy is actually healthy because it indicates strong demand for goods and services in the economy, which of course is positive.
UNEMPLOYMENT is a measure of joblessness, expressed as the percentage of people in the labor force without a job. Clearly, the lower this number is, the better.
Once we have developed a firm grasp of how these key indicators affect the Philippine economy as a whole, then we can relate it to how it affects the stock market.
The stock market and financial markets
The stock market is made up of the country’s largest companies in the country. When the economy is doing well, that is, when GDP is growing reasonably fast, inflation is stable, and unemployment is relatively low, then these companies should be doing well and should experience robust sales of their products and services, and in turn, strong earnings, all else being equal. This should then mean that the company is growing and hence is becoming more valuable.
When you buy a stock of a company from the stock market, you become an owner of a part or “share” in that company, so the more valuable the company gets, the higher the price of that share goes.
The savvy investor must therefore be able to read signs and anticipate changes in economic trends, that is, when things are about to turn bad, and vice versa, as these trends will likely impact the business of a company in which you own a share, and ultimately, the value of that share.
You can think of financial markets, like the stock and bond markets, as a superpowerful computer that processes the expectations of all the buyers and sellers out there, based on everything that is happening in the world, and then spits out a market value or price for a particular stock or bond instantly.
Because people have different views and opinions of what to expect in the future, these market prices are in perpetual motion, always moving as each new expectation is “priced-in”. Sometimes, they move a lot, especially in times of great uncertainty, just like what happened when the pandemic was announced. These changes in prices over time is what is referred to as volatility.
Savvy and successful investors
During periods of high volatility, when prices are swinging around rapidly, the savvy investor is someone who stays level-headed and doesn’t give in to emotions. This is easier said than done, because we are only human, and the forces of greed and fear, euphoria and panic, are indeed very strong.
How do you do this? By starting with a deep knowledge base before you invest your hard-earned money. You need to know the risks involved and understand the level of risk you’re willing to accept and tolerate. Again, the greater the expected reward, the greater the risk you must be willing to take. Successful investors tend to be those who are always learning and planning and are usually a patient bunch.
When you are armed with this knowledge, then you can make better decisions about your investments, even when markets are volatile. This continuous learning process should involve regular discussions with a trusted investment adviser with a strong handle on very complicated markets. In Metrobank, we call them Investment Specialists. Another alternative to consider is to engage the expertise of a professional investor, such as a fund manager from Metrobank Trust, whose main job is to maximize investment returns while managing risks.
RUBEN ZAMORA heads Institutional Investors Coverage Division, the relationship management unit for Non bank Financial Institutiions in Metrobank’s Financial Markets Sector. Prior to joining Metrobank, he was based in Singapore with UBS, Credit Suisse, and BofAML (now BofA Securities) for Asia ex Japan equities sales and account management. He holds an MBA from the University of Chicago.
This opinion article is part of Metrobank’s Financial Education campaign series.