The economy is not the market - don’t panic
How will markets react to the upcoming elections? Is your pension safe?
These and many other headlines have been popping up in recent weeks as the media try to make sense of the current political uncertainty and our upcoming national elections. Fundamental to their question is the assumption that negative political news will influence the economy and that the markets will follow suit, leaving your retirement savings at risk.
Speak to any market analyst and you will be told that the markets are not the economy and that there is very little, if any, correlation between the performances of the two.
To understand that a bit better and to breathe easier before the May 8 elections, let’s look at the two concepts. The economy, as defined in the dictionary, is the balance between our production, trade and supply of money. The market is where we trade in stocks and shares for profit.
It is not surprising that the two concepts are believed to be closely related and that the one would influence the other. For example, you will read statements such as “the economy is in decline, so the market for new cars is shrinking”, which creates the impression that the economy weighs heavily on various “markets”, including the stock market.
Interestingly, the academic research on this topic is quite clear and it shows that there is almost no correlation between the growth and contraction of the economy and the performance of the markets.
This means that the stock market could be performing well, even though the economy is barely positive, as is the case in SA. One of the reasons for this often-inverse relationship is that the market is more fluid. Money flows in and out quickly, while the economy often reacts slower, and longer, to changes in buying patterns, investment and trade.
This is especially true for the SA stock market, which is very highly traded. Money flows in and out at a rapid rate, which will buoy the market, or cause large movements, with little or no relation to the economy.
Then there are factors such as size and international stature. While our economy is tiny in relation to the rest of the world, it is larger than the market and its collection of company stocks and other investment instruments. The market, in turn, is often grouped with other emerging markets and analysed, and traded, as a whole. This means that our market returns are often viewed not as a function of the economy, but in comparison to other emerging markets such as Brazil and India, leading investors to flock to our larger returns, even though our economy might be struggling.
Another point of interest, especially in SA, is that we trade in many stocks of companies that earn most of their income offshore. In fact, more than 70% of the JSE Top 20 companies’ income is generated abroad. As such, investors pay little attention to the local economy when deciding to invest in these companies that have their listing on the local market, but which earn foreign currency.
So where does that leave you? Perhaps the difference between these concepts has left you even more confused as to whether you should stay invested or move your money into a “safe haven” such as cash or property.
Ultimately, history has taught us that the market will grow steadily over time and that a carefully selected portfolio of good stocks in a balanced fund will outperform stock pickers who try to find correlations between news, economic indicators and market movements.
It also teaches us that the collective wisdom of a well-traded market quickly factors in external risks and economic changes, where relevant, and that you, as an individual, will usually react long after the market has “priced in” any economic risk.
Many people make poor investment decisions when they get spooked by bad economic news, sell their stocks when the market is declining and then try to buy back into the market when it turns around. Since it is almost impossible to time the market perfectly on a consistent basis, you will probably end up losing returns on your capital over time due to not getting the timing right and incurring additional trading costs.
So, take a deep breath and do not do anything hastily during the news frenzy that is a national election. Rather, seek council from an independent financial adviser who can both help you choose a good long-term investment strategy and buffer you from the barrage of negative economic news and your urge to act on it.
• Fourie is the MD of Ascor Independent Wealth Managers and 2015-2016 FPI Financial Planner of the Year