How to focus on the economics that matter when investing

The world of investing as we know it today can be a very intimidating place, especially when trying to understand the volumes of information entering the market place on a daily basis. New economic data of various kinds are published on a daily basis, with thousands of related articles and opinions written every minute.

The trick to be a successful investor is to know what’s important and to separate this information from the noise. If not, you will be caught trying to make sense of millions of pieces of information that has no material influence on your investment.

 The following investment snips of knowledge can assist investors to focus on the most important economic information.

  1. Macro forecast is generally wrong, so ignore most forward-looking data.
  2. Ignore data that has a frequency inappropriate to your investment horizon. Looking at high frequency data if you are a long-term investor is a waste of time.
  3. Buy stocks that will do well regardless of the economic cycle and stop worrying about the economy.
  4. We cannot predict the economy any better than we can predict the stock market, in fact, in the short term the financial markets predict the economy better than the other way around.

Given the above advice there are some very important economic data investors need to keep an eye on. These include interest rates, inflation, the business cycle and related variables to the before mentioned. Any other economic data can be safely ignored.

Interest rates

This refers to the repo rate as announced by the SARB. There is an inverse relationship between interest rates and market movements. Markets go up when rates go down and vice versa.

This being said, there are outside factors, such as political uncertainty and market gyrations that can overshadow the effect of interest rates on the market.

There is no sector that will outperform during times of rising interest rates. The best strategy when interest rates are rising is to be in the sectors that are less sensitive to these movements.

Sensitive sectors include the following: Telecoms and platinum.

Sectors that are less sensitive include Gold, transport, speciality finance, investments companies, and food and drug retailers. Interestingly, the markets are five times more sensitive to interest rate declines than interest rates increase.

Inflation

Inflation is the general increase in the price of goods and services. Inflation is measured by CPI (Consumer Price Inflation) and released monthly by StatsSA. Inflation influences consumer spending, because the more expensive things become, the smaller the portion households have left at the end of the day to spend on consumption.

This is important because consumption is a key driver of the economy and economic activity in South Africa.

Inflation has a negative influence on asset classes such as equities and bonds. During a time of rising inflation, cash is king.  

Other important factors linked to inflation include money supply and nominal wage growth.

Business cycle

The business cycle or economic cycle is a combination of booms and recessions or upswings and down swings. The business cycle is important because earnings growth usually coincides closely with GDP growth, and as you know earnings growth drives returns.

The average business cycle usually lasts around four to five years. 

In South Africa, an upswing is longer than a down swing. Upswings usually last around 26 months, where a down swing lasts around 16 months.

The indicator commonly used as a measure of where the economic cycle is, is the Gross Domestic Product (GDP) of a country. The problem of GDP as a measure of economic activity is that GDP lags economic activity by at least a quarter.

Other measures of economic activity also include: commercial vehicle sales (leading), retail sales, employment, personal income, industrial production, manufacturing and trade sales. The yield curve is a good predictor of GDP growth. One can use the yield curve to predict both GDP and market earnings growth.  

  • Werner Erasmus is the Gauteng regional manager of Overberg Asset Management. Look out for Overberg Asset Management's weekly column on Fin24.

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