APART from seeking professional financial advice, a shrewd retail investor should carefully interpret economic data as part of his overall investment strategy decision.
Josephine Tan, a long-term retail player, regularly scans the business pages to monitor trends in economic growth, inflation and the performance of the manufacturing sector before committing her hard-earned cash to a particular unit trust or bond fund.
Economists approve of Tan’s strategy. They point out that in the Malaysian context, the stock market doesn’t provide an accurate picture of the health of the real economy. This is because many retail investors draw their own conclusions based on market sentiment, speculation and geopolitical risks rather than concrete economic statistics.
Instead, investors should observe how these indicators help predict the reliability of their investments. Retail players can start off by familiarising themselves with key economic barometers – the gross domestic product (GDP), leading index, industrial production index (IPI) and manufacturing index.
Other important indicators for the long-term retail investor are industrial productivity, the loan growth of commercial banks, foreign exchange rates and interest rates.
It is also important to note that Malaysian economic indicators comprise composite indices of leading, coincident and lagging indicators. They signal changes in the direction of the country’s economic activity. The Statistics Department regularly publishes these indicators, which can be used by long-term retail in- vestors to understand economic growth cycles.
Key economic indicators – what institutional investors look at
GDP, a much-watched global economic indicator, is a strong summary of economic performance. Defined as the value of goods and services produced within a country, it reflects the rate at which the economy is growing. Another vital indicator is the leading index. The leading indicators measure anticipations or new commitments to economic activity, which will af- fect the overall economy in the months ahead.
Leading indicators tell us where we are going. For example, it can provide an early sign that an ongoing economic expansion may start to decelerate. In September 2002, the leading index grew by 8.4%, easing from 9.9% in the previous month.
The Malaysian Institute of Economic Re- search (Mier) tracks the leading index on a monthly basis. Using these data, economists gain an insight into future economic growth.
The coincident indicators measure the overall economic performance. It indicates where we now are in economic growth. Lagging indicators tell us what has happened to the economy. They measure the cyclical movements of both leading and coincident indicators.
Investors should also closely examine the Industrial Production Index (IPI), a measure of the industrial output of a country. Malaysia’s industrial production grew by 7.5% in the third quarter of 2002, but it eased to 6.4% in October 2002, as growth in the manufacturing sector had declined, according to Mier.
A key contributor to GDP growth is the manufacturing sector. The manufacturing sector moderated to 5.8% in the fourth quarter of 2002, from 7.3% in the previous quarter.
Interest rates and the ringgit peg
Most economists agree that the ringgit peg provides a stable financial environment for the country. They assert that if it remains, it is likely that interest rates will be constant. The ringgit peg has facilitated trade and investment, and the government now needs to strike a balance between maintaining the ringgit peg and ensuring a steady pace of economic growth.
As a rule of thumb, interest rates are typically low in the recovery stage of any economic cycle. But as economy recovers, rates move up gradually as financial regulators look to control inflation.
Understandably, interest rates affect our investment decisions. For example, if fixed deposit (FD) rates decline to 3.5% from 4%, investors will likely find other investment options that perform better than FD.
Variations in interest rates can have an overwhelming effect on share prices. This is because interest rates impact stock prices through their effects on corporate earnings and dividends, the volume of margin trading and the bond market. Rising interest rates have a negative effect on stock prices. In contrast, declining interest rates positively impact earnings, dividends and share prices.
In addition, interest rate fluctuations affect a company’s borrowing costs. Companies borrow funds to finance large capital expenditures. For instance, if a firm borrows RM50mil at 10% per annum, then it pays RM5mil as interest each year. However, if the annual interest rate rises to 12%, it will have to fork out RM6mil. Higher rates effectively translate into lower corporate profits, one of the main drivers of company share price.
Hidden value in market indicators
Rather than making a haphazard guesstimate, investors should compare the link between economic indicators and the stock market’s performance over a long timeframe. Institutional investors tend to capitalise on this relationship.
This will enable retail investors to gauge how the economy influences the stock market in the long run. Economists argue that the real economy has a pervasive impact on the performance of companies listed on the stock market.
Ideally, the stock market should act as a barometer, or leading indicator of the performance of the economy. In efficient markets, the stock market actually factors in the latest developments and outlook of the economy locally, regionally and internationally. On that basis, efficient stock markets fully factor in expectations of the risks and returns of the real economy.
Understanding the macroeconomic environment and the main economic indicators will help the retail investor identify companies in potentially high growth areas. This will allow them to capitalise on future growth prospects.
Furthermore, these are long-term asset allocation decisions that the retail investor can benefit from to build up value in his portfolio. Retail investors should also look out for companies that are best able to integrate technology, markets and services, as this will ultimately benefit their long-term performance.
The status of regional and global economies
Of course, Malaysia’s economic indicators only reveal part of the story that should interest investors. Asia’s regional markets are inextricably linked to the US and European economies, and developments in the US affect Malaysian exporters and corporations.
Given growing intra-regional trade and economic connections, Malaysia’s neighbours can also impact our economic performance. As a result, the amount of variables that must be taken into account before an investment decision can be logically formed is immense.
So while retail investors should take the opportunity to examine macroeconomic indicators before making long-term investment decisions, they might also do well to take some professional advice from a well-established financial advisor should they want a clearer lead from market indicators.
·The above views reflect those of Citibank Bhd as at the publication date. They are intended for general information and/or discussion of the topic. They are not intended to be relied on in any way by any investor in foreign currencies or other investment products.
While every effort has been made to ensure the accuracy of the information, no liability whatsoever will be accepted by the bank or the author, whether in contract, tort or otherwise, for any error of fact or omission herein which may lead to any direct or consequential loss arising from any reliance upon or use of this report.
Investors should seek independent professional advice before making any investment or taking any course of action towards investing.
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