This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, it is subject to change and we are not responsible for any errors or omissions.
The economy is a bit like the “ocean” that your investments “float” in. During harsh weather (e.g. a recession), your investments might experience turbulence, leading to short-term price volatility.
Conversely, a growing economy can provide powerful tailwinds to your investment performance. Yet, how does the economy affect your investments, exactly? Should you factor economic variables into your investment decisions?
Below, our financial advisers at Scottsdale explore these questions in greater detail. If you want to discuss your financial plan with a member of our team, please get in touch to arrange a no-obligation financial consultation at our expense:
+34 966 460 407
info@scottsdale.eu
The UK economy – an overview
How do you judge the performance of an economy? Typically, governments base their economic objectives on at least one of five main “macro indicators”:
- Unemployment
- Growth (real GDP)
- Inflation
- The current account
- Stable government finances
For instance, during the 2010-15 Coalition Government, the UK focused primarily on the fifth objective—achieving a balanced budget and reduced national debt via “austerity” (lower spending and/or higher taxes).
More recently, Rishi Sunak’s Government has concentrated mostly on reducing inflation to the 2% Bank of England (BoE) target.
These objectives are often interconnected. For example, high employment and low unemployment typically accompany higher GDP growth (Objectives 1 & 2). Moreover, politicians also need to consider trade-offs when conflicts in objectives occur.
A typical example is growth and inflation. High growth can lead to a rapid rise in prices (inflation), which can “overheat” the economy. If not kept under control, hyperinflation could occur, leading to price-wage spirals.
How does the economy affect investments?
It is complicated! To take the weather analogy again, predicting the impact of economic variables on investment performance is like trying to predict when a storm will occur, how severe it will be and what impact it will have (e.g. on local wildlife). You can make some educated guesses based on data. However, nobody has a crystal ball.
For instance, let’s hark back to COVID-19 in 2020. When the pandemic swept across the world, markets suddenly took a downward turn in March-April as investors realised the severity of lockdown measures. However, the crash was short-lived. One year later, stocks had recovered.
Why did this occur when previous market crashes – e.g. The 2008-9 Financial Crisis and the Great Depression of the 1930s – lasted so long? One answer is the responses of central banks in western countries.
In the UK, for instance, the BoE responded to the 2020 COVID-19 Crash with cuts to interest rates and heavy injections of “quantitative easing” (increasing the money supply to stimulate spending). This, arguably, kept up aggregate demand and prevented a demand-side crash.
Could investors have predicted the events of early 2020 and central banks’ responses? It is highly unlikely. With the beauty of hindsight, some investors have argued that events in 2020 were obvious ahead of time. However, those who remember those days will know better.
Navigating the economy as an investor
So, should you simply ignore the economy when building a portfolio? Not exactly. Whilst investors need to be careful not to try “timing the market” based on predictions about the economy, macro indicators cannot be ignored when selecting investments.
A good case in point is interest rates. These often have an important impact on the investment landscape because they affect bond yields (thus, indirectly, changing the appeal of equities – i.e. stocks/shares).
Generally, when interest rates go up, the yield on newly issued bonds goes down. This makes bonds less attractive to investors. Consequently, more investors might flock to equities in pursuit of higher returns – pushing up valuations.
However, it is not an iron-clad rule that rising interest rates will result in higher stock market prices. Other economic variables can derail this outcome. Moreover, the wider market often “prices in” predictions of future rate falls/rises before individual investors.
As such, it is nearly impossible for individual investors to “beat the market” based on what they believe will occur with interest rates. Professional investors simply have access to more information and have a closer “ear to the ground”.
So, what should you do? A good rule of thumb is to assume that trying to beat the market is a fool’s game. Rather, investors are usually better off spending “time in the markets” to reap their long-term rewards.
Portfolio decisions should be based more on sound investment principles instead of short-term predictions about the market and wider economy. These include:
- Diversifying across different asset classes, markets and geographic areas.
- Following your risk tolerance.
- Accounting for your “investment horizon” (how long until you will need the money?)
- Underlying fundamentals of an investment, such as fund liquidity.
A financial adviser can be invaluable in this process, helping you avoid the temptation to “time the markets” and follow time-honoured principles.
Invitation
If you are interested in discussing your own financial plan or inheritance tax strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
+34 966 460 407
info@scottsdale.eu