Along the journey of investment, we may need to act like a rubber band, which is resilient and flexible, to deal with different economic and financial environments.
The economy runs in a cycle, sometimes expanding, and sometimes contracting, and the financial markets are in different phases at different stages of an economic cycle. Recently, inflation, interest rate hikes and the possibility of recession have been the main worries of the investment market.
Inflation and rising interest rates
Many countries and regions are facing the problems of high inflation. Inflation means a general increase in prices, and its causes are complicated. The damage to the global supply chain and freight industry caused by the pandemic that has been dragged on for over two years, rising energy prices and the conflict between Russia and Ukraine are some of the reasons behind the current run on inflation. However, the causes of inflation are different for different countries and regions.
Raising the interest rate is a common monetary policy used to suppress inflation. With inflation in the United States remaining high, the Federal Reserve has raised interest rates several times this year. Following increases of 0.25% and 0.5% in March and May, a further 0.75% rise was declared in June, July and September, respectively. The market expects the Federal Reserve to continue to increase interest rates heavily in the near term. With the Linked Exchange Rate System, Hong Kong may also increase interest rate.
The stock market goes before the economy
The performance of financial markets is highly related to the economy and understanding the relationship in between is beneficial for our investments. In the case of the stock market, it seems natural, to say “stock market performance reflects current economic situation”. However, this is not necessarily the case as the stock market tends to perform ahead of the economy, usually by 3-6 months, and is a tool for measuring economic prospects. For example, after the US Federal Reserve’s heavy-handed interest rate hikes, whether the US economy will experience a recession next year has been the focus of recent discussions in the financial markets. Whenever there are warning signs of a recession, such as an inverted yield curve (meaning short-term interest rates are higher than long-term interest rates), or a drop in consumer confidence, the stock market will often be the first to react rather than wait until a recession is confirmed.
Investment is a 'forward looking' business and being able to look ahead to the performance of the economy allows you to invest accordingly. Yield curves, consumer confidence, PMI, M2 money supply and stock market indices such as the S&P 500 are all commonly used as leading indicators of economic trends. Paying more attention to the movements of these leading indicators can help us avoid being "lagged" in economic changes and help us to be more resilient and flexible in our financial management.
