(Macro)Economic Analysis: Why should Investors care?

Is it Really Necessary?

These days trains in India are too full to move but there was a time around a decade ago when we could actually run through compartments. As small kids, my siblings and I used to run against the motion of the train to see who can stay at the platform for a longer time. No matter how hard we tried we had to leave the platform as we could neither run faster than the train nor leave the train. 

So what it has to do with the economy and investment?

The economy is like that train and companies are like the kids. If the economy is growing rapidly even weak businesses tend to grow and when the economy is falling even great businesses suffer. 

If you manage to buy a great business when the economy is just starting to grow and sell the business before the economy starts falling then you can make a great deal of profit but it is not that simple.

Firstly, if the economy is just starting to grow means we have came from recession/depression. This is a phase where it is rare to have spare money for investing. Most people will earn enough money after growth has actually started. 

Secondly, it is really hard to predict the next phase of the economic cycle in advance. (we will discuss how it can be done but in the end, it is a skill and not theory which can be taught.)

So what is the solution?

The solution is to keep analyzing macroeconomic data to make sure that we are at least not in the contraction phase while investing. Boarding the train at the second or third station is not a bad idea what we have to make sure is not to get in one which going against our destined direction.

It will hard for a lot of new investors to connect with this discussion as they have never seen a depression (negative growth) at most they may have seen a recession (slowing growth) and still have seen companies going bankrupt. This situation occurs because of sector-specific or company-specific factors and that is the reason why we have dedicated the majority of our articles to company analysis and only one for economic analysis. But this doesn't make economic analysis useless as it will be the savior in times of depression.

Economic Engine:

GDP is a widely accepted measure for evaluating the performance of an economy but it is a lagging indicator. What counts best is future GDP and evaluation of future GDP comes from the understanding of the economic engine. 

The economic engine produces products and services that have some value(GDP). Employees are the fuel for the economic engine while policymakers(finance ministry and central bank) are operators. The operators have a screen showing economic data points(Inflation, Unemployment, CPI, etc.) according to which they decide to increase or decrease the speed of the engine by turning the knob(Interest Rate, stimulus packages, taxes, etc.) lower or higher.

The task for the operator is to keep the engine running at a manageable speed; which is neither too low nor too high. Everybody knows low growth can cause problems like unemployment but very few know that too high growth can be more fatal as it will cause inflation to soar beyond the point of control. Rising inflation will destroy the value of the currency and the economy will suffer despite growing fast.

Anyways the point is the Finance Ministry and Central Banks will try for achieving moderate growth so that the economic engine keeps running without bursting.

The Working:

Whenever an employee/group of employees produce something (Product/Service) which can be sold in return for the money it is said to be produced and is calculated in terms of currency. Calculating all such productions in a country within a specific timeframe and adding them together gets you to GDP(Gross Domestic Product).

Now if GDP is increasing that means the total value of production in the country is increasing ultimately sales and profits of companies are increasing that is what an investor wants.

But how does GDP increase? It increases in either of three ways:

1. Domestic Consumption Increases.
2. Trade Surplus (Export-Import) Increases.
3. Both Domestic Consumption and Trade Surplus Increases.

Reverse for decreasing GDP is also true.

Domestic Consumption:

GROWTH : Increase in domestic consumption not only increases GDP but also increases inflation. How?

Inflation is effect of supply demand imbalance. Whenever domestic consumption increases there is increase in demand and if the supply do not increase at the same pace it is obvious to have inflation. Untill the inflation rate is in moderate range there is no worry but as the inflation goes beyond that range policy makers have to step in. 

RECESSION START: In such a scenario where inflation is too high RBI tend increase Interest Rates so that borrowing becomes costlier and demand decreases by some amount which intern causes inflation to ease a bit and GDP growth also slows down.

RECESSION END: On other side if GDP growth is slowing because of low domestic demand RBI reduces Interest Rates to make borrowing cheaper and saving inattractive. This cause people to save less and spend more even with borrowed money which intern increases demand and GDP growth as well.

DEPRESSION: In few extreme cases(like major natural calamities, war situation, extreme political instability, etc.) reducing interest rate even does not increase consumer confidence and they tend to save as much as possible. Such scenarios causes depression.

Trade Surplus/Deficit:

Trade surplus is when the country is exporting more and importing less while reverse is trade deficit. This balance of trade is dependent on so many global factors along with country's foreign trade policy. While foreign trade policy is in control of ministry of commerce and industry most of the global factors are not in anyone's control. Hence controlling and making any judgements based on foreign trade is hard at least for me. So I really don't give too much importance to this topic while analyzing economy for investment purpose. Being a consumption based economy Domestic Consumption is one thing I focus a lot.

I hope you got some good insight into economic analysis for investment purpose through this article. If you want further explanation please make sure to comment below.

And don't forget to READ TO LEARN INVESTING.