2018 has been an interesting year, companies have experienced exponential growth and the economies of many countries have grown or stabilized their GDP’s. Although there are unfortunate cases like that of Venezuela experiencing high rates of inflation caused by corruption and unstable financial infrastructures, companies in many parts of the world have generally done well this year with the likes of Amazon breaking earnings record during the Christmas Holiday. In August Apple became the world’s first trillion-dollar public company as a rise in its share price pushed it past the landmark valuation. This and many other factors pushed the Economy and Capital Markets forward. Though coming to the end of 2018, the results were conflicting making people question what was really going on. This is the aspect I wanted to focus on and discuss. I have summarized some of the research and insights I discovered over the year during my quest for answers and wanted to share my findings in a brief and easy to understand way.
During this article, I am going to make two distinct assumptions, the first being that you are aware that the Capital Markets and the Economic Markets are two different things. The Economic market consists of the trade of cash transitions for assets or consumer goods and services between Consumers, Corporations and Governments. On the other hand, the Capital Market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold. They channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. The second assumption is that the cases and examples I will use are all North American based because this is where I currently reside.
There are many economic indicators but there are three main factors that are looked at as indicators of the current economic position that a country is in the first one being the GDP which is a monetary measure of the market value of all the final goods and services produced. The second is Inflation Rate a fancy term for the increase in prices of consumer goods and lastly the Interest Rates which are the amounts charged, expressed as a percentage of principal. These indicators are all affected by what the Central Bank of Canada and the Federal Reserve of the USA, they use them to stimulate the economy.
I have taken the liberty of putting the figures in an easy to read format in the table below and added China and the Euro Area for comparison’s sake. (Trading Economics, 2018)
At first glance, the numbers do look intimidating, but I assure you they are not. To keep the article short and sweet let us focus only on the figures for USA and Canada. Looking at the figures of GDP we can see that clearly, the United States is a larger producer and consumer of goods and services compared to Canada. This figure alone does not give us the full scope of the economy. The GDP YoY compares the figures from 2017 to 2018 and there has been a 3% and 1.9% increase in USA and Canada respectively. This is an indicator of economic growth showing that companies are being more productive in 2018. The interest rates are currently 2.5% and 1.75%. In October the Canadian Central Banks Increased the Interest Rates from 1.25% to 1.75% this is an indicator that they are trying to cool the economy, we will discuss this further later on in the article. The Inflation rate has gone up to 2.25% in the USA and 1.7 % in Canada.
The Central Bank and the Federal Reserve
You should think of the economy as a cycle it has high moments and low moments it is on a continuous pendulum shifting from hot to cold. When we mention the hot economy, this refers to when the market is experiencing increasing GDP, companies are breaking earnings records, Consumer and Government spending is high and interest rates are low or close to zero, so banks are giving out loans and mortgages. This causes many people to have more disposable income(debt), thus there are billions of transitions occurring in the economy. Vice Versa we have a cold economy where there is less economic activity. Keep in mind this is not always a bad thing.
To control these fluctuations, we have federal organizations like the Federal Reserve who control the money supply and interest rate and the Government who control the tax rates. They have 4 driving forces to cool and heat up the economy, for now, I will just mention them as they deserve an article of their own;
A. Tax the rich – The Government would increase the tax rate on the wealthy so as to distribute the money and achieve “equality”, they would use this the tax revenue to buy municipal or corporate bonds.
B. Interest Rates – The Central Banks and the Federal Reserve adjust the interest rates to increase and decrease the prices of assets, as well as to stimulate the banking industry to give more or fewer loans there by increasing or decreasing economic activity respectively.
C. Print Money – This is Economics 101; the Central Bank can print money and inject this capital flow into the economy through banks by doing so they increase the consumption of the economy. The one drawback of this is that it can cause high rates of inflation if not managed well.
D. Buying Municipal or Corporate Bonds – The Central Bank will buy government bonds and then the government will buy corporate bonds and thus increasing the money companies have to spend.
The last part of our journey together is the driving force for all the fear in the last quarter of the year, the Financial Markets. I decided to make this a short section because this deserves an article of its own, and I am currently working on one. The main goal of having it in the article is to differentiate the Economy from the Stock Market. The Capital Markets consists of banks and other deposit-taking institutions, but we shall focus on exchanges and investment dealers. These Investment dealers and exchanges are how capital flows in the economy. In the aforementioned article, I talk about how the two driving forces in the stock market are fear and greed. America has been in the best bull market for the last 10 years since the 2008 financial crisis and there have been talks of a market crash that should happen soon. This and the trade war being faced by the USA with China has caused a lot of speculation in the stock market and Investment management companies bank on this fear and volatility. Because of the low-interest rates Institutional and retail Investors would purchase a large number of securities driving the stock market up causing companies like Apple to reach trillion-dollar status, this is what happened in 2008 and 2000 with the Dotcom crash, so many analysts would go on the news and sell the idea of the crash to come in the next two years increasing the sentiment of fear in the market.
Now the big question is there a big financial crisis on the horizon. To the answer this I will say one thing that should encompass my sentiment about the stock market currently and in the coming two to three years.
“The only thing predictable about the Stock Market Life Cycle is its unpredictability, that is all.”
– Takudzwa Ndachena