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Economic forces should be considered as they ultimately affects the performance of
the industries and companies. Fundamental-driven investors look at economic indicators
to determine the course of the economy. Economic indicators signal future change
in the economy.
In a fundamental-driven and an established market such as in the United States, investors
are very sensitive to statistical releases with both domestic and international relevance.
Key data such as inflation, interest rates, Gross Domestic Product (GDP), etc are
normally monitored. Nevertheless, interpreting or applying economic statistics is
not an easy task even for the experts, let alone the ordinary investors. Thus extreme
care needs to be taken.
These indicators are not just simple numbers as they affect everyone's lifestyle.
Thus, investors should know roughly what is happening in the economy so that they
can make appropriate investment decisions. Even if the economy is growing, investors
still need to ascertain the pace of the growth - whether it is growing slowly or
rapidly.
For example, during periods of rising inflation and interest rates, a companyís profits
may not be so attractive due to rising costs. Higher interest rates will make it
more expensive for companies to borrow for expansion purposes - companies are more
likely to delay new projects - all this will translate to lower stock prices of the
companies affected.
Higher interest rates also impact individuals who have numerous loan commitments.
Consumers should reduce their spending as they feel the pinch as a result of the
impact of rising prices. All these generally point to a slowing economy and bear
stockmarket trend (Chart 1).
Unexpected major events can also affect the performance of companies or stockmarkets.
Stockmarkets worldwide gyrated after Iraq invaded the tiny oil-rich Kuwait on August
3, 1990. Anxiety and fears about the Middle East tension caused oil prices to jump
- companies which depend on oil supply and petroleum products from the region were
affected.
During periods of uncertainty, not all companies will be affected in the same way.
Fundamental-driven investors should select stocks that are least or not affected
- so called defensive stocks. What are defensive stocks? Defensive stocks which typically
maintain their values during recessionary periods are companies producing staples
such as food, beverages, tobacco, pharmaceuticals.
Cyclical stocks are likely to be dumped during an economic downturn. Cyclical stocks
such as property and motor vehicles are issued by companies that are vulnerable to
changes in economic trends.
The values of these stocks tend to go up during economic boom and go down during
economic slowdown. Table 1 illustrates further the general investment strategies
during different investment periods.
This article provides investors with a very basic process of valuation based on fundamental
analysis. Given the complications of todayís unpredictable financial markets, even
the most astute and cautious investor do not get it right all the time.
Investors should understand that investing in stocks carry a higher degree of risks
compared to other forms of investments but it also means a higher rate of. To minimize
potential losses, you should not speculate unnecessarily. The economic crisis facing
the local economy should not be a deterrent for fundamental-driven investors who
wish to invest for the long-term.
While the market is still jittery investors can adopt a counter-cyclical approach
- "buy in gloom and profit in boom". Investors with strong cash flows and
belief in fundamentals with the capacity to absorb short-to-medium fluctuation can
profit by investing when confidence is at its lowest.
An understanding of fundamental forces can do more than help you to make rational
and better-informed investment decisions. Seek independent advice from the professionals
if in doubt.
We must acknowledge that we operate in an uncertain world and dealing with future
events that we cannot see. Investors who buy on fundamentals and not on rumors are
likely to benefit over the long-term. Be wise - learn how to invest fundamentally
and most importantly "know what and why you buy".
Table 1. General Business Cycles and Investment Strategies
| Late recession |
Shifting portfolio to good quality cyclical stocks. |
| Early expansion |
Increasing weighting towards cyclical stocks and growth stocks. |
| Middle expansion |
Reduce weighting in growth stocks and start building cash reserves. |
| Late expansion |
Take profits in cyclical stocks. Increase cash weighting and start buying defensive
stocks and utilities. |
| Early recession |
Increase weighting into defensive, utility and high-quality, non-cyclical growth
stocks. |
| Middle recession |
Start taking profit in defensive and utility stocks. |
Source: Normandy Research
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