Three Important Things Everyone Should Be Looking At.

You’re making money on the stock market, we’re making money on the stock market, everybody’s making money on the stock market. But have you ever stopped and wondered why share prices have been increasing dramatically over the past 9 months? Have you also wondered what could trigger a change in these excellent market conditions that could potentially lead to a crash ? Well, if you’re invested in the stock market our informal advice to you would be to look out for these three very important signs, which could impact the stock market pretty heavily.

Inflation

Around 1 year ago, the markets came crashing down due to the Corona Virus pandemic. As we know, the virus has led to subsequent lock-downs of global economies.

In order to reduce the economic impact of the coronavirus, Governments around the world were forced to print money and distribute to organisations and people who may have lost their jobs.

Just to put things into perspective, the worlds global debt figure before the Corona virus was started to be 255 Trillion, and is now 281 Trillion, increasing by approximately 9%. What is also important to note is, that in 2019 global economies were stacking on record breaking amounts of debt. In 2018, global debt was stated to be 188 Trillion, meaning that from 2018 to 2021, global debt increased by a staggering 33%.

So what could this potentially mean?
Well, what happens in practice and what happens in reality tend to differ. But for practicalities sake, when there is too much money in circulation, inflation occurs leading to an increase in the price of goods, prompting the purchasing power at the level of the ordinary consumer to diminish.

Inflation as such is healthy for an economy given that it is within a bracket of 1–2% per annum, anything higher than this may have negative implications on an economy.

So, what would Governments do to control high levels of inflation brought about by an increased money supply?

In theory they would adopt both monetary policies (money policies) and fiscal policies (tax polices) to influence the money supply.

Monetary Policy

Refers to the actions undertaken by a nation’s central bank to control the money supply and to achieve sustainable growth. In theory, if the supply of money is too high, then the central banks would generally increase interest rates to discourage spending. 
For example, if a person wishes to obtain a home loan in the current market, the fixed interest rates on a loan would be approximately 3%. However, to discourage loan taking (and ultimately the total supply of money), the central bank would increase the interest rates to say 6%. 
Most people and businesses may (in theory) reconsider that loan.

Fiscal Policy

This is the means by which a government adjusts its spending levels and tax rates to monitor and influence the economy.
Assuming that the amount of money circulating within an economy may be over the ‘healthy’ limit, then governments may increase tax rates to contract the amount of money circulating within the economy. 
With higher tax rates, individuals and companies will end up with less money in their pockets and may be discouraged to spend more.

So, what does this mean at the level of the organisation?

Remember at this point in time organisations are paying very little to acquire their debt (loans and other forms of liquidity), and in addition to this, governments are helping organisations by offering lower tax rates, to ensure that Companies can weather the pandemic a lot easier. If things change, then an organisation may suffer financially. (as explained below)

So, what if things change when the economy opens up again?

Well, if the government and the central bank decide to contract the money supply through the implementation of fiscal and monetary policies then we can assume that the cost to acquire debt is going to rise (through increased interest rates), possibly coupled with increased tax rates at the level of the organisation, and the consumer.

How will this effect the organisations and consumers power to engage in business ?

Organisations may see if profits diminished through higher tax rates, but its important to note that if an organisation is paying its taxes, then it’s profitable. 
That is the long-term should be seen as a positive indicator because the company is in a good position to bite the bullet and sail through the rough seas. But keep in mind that an effect on an organisations profitability may impact the share prices.

Where the concerning part lies is within the increase in the cost of debt ( such as interest rates). If a Company holds a significant amount of debt on its balance sheet, then this may have some significant effects on your investment. High interest rates will hit the overall profitability of your company, and may also hinder a Company’s chances of acquiring new loans or paying the ones they currently have. Meaning both companies needing to borrow and companies already borrowing will be impacted. 
Lastly, if a company is not in a position to restructure its finances to meet its financial obligations, then the company may need to resort to selling off its assets to pay its debt.

At the level of the consumer higher rates of inflation will discourage individuals to engage in basic economic activity, meaning fewer goods and services will be consumed hurting the overall profitability of a Company.

When investing in a Quality Company it is vitally important that the company has a strong balance sheet and can cope with recessionary period pretty well. These wo
uld be more commonly found in value stocks, or some tech-based stocks that have fortresses as balance sheets and literally No Debt.

Growth companies may be hurt more than the value plays in these conditions simply because their financial capabilities are miles away from the ‘value stocks.’
In addition to this, organisations in their growth stages often tend to be loss-making and have a significant amount of debt on their balance sheets. These sorts of companies may struggle to cope in a recession.

Remember, strong balance sheets are sexy.

Just to make our points a bit more relevant, we decided to attach a current inflation index that was issued by the european central bank not too long ago. Food for thought.

Bond yield index

At this current point of time, Global bond yields are pretty low with most returns being in the ranges of 0–1% per annum. In the eyes of an investor, investing in bonds does not make much sense. Simply because with the expectancy of making 1% return on your investment, you might be better off investing in the stock market in hopes to make a higher return, and let’s be honest, in 2020 you made your returns.

So what would happen if bonds suddenly increased to say 5% year over year? Then bonds could be seen as a decent investment, potentially causing a mass shift of funds out of the stock market into the Bond market. This mass shift of funds would pretty much upset the stock market, potentially causing it to crash, or result in a long-term down trend.

Keep your eyes pointed towards bond yields.

Other Cyclical Factors

On average the stock market incurs a ‘crash’ every 7 years. By historical measures we are considered to be overdue, but of course we are living in a funny time, and nobody really knows what to expect.

However, to complement our crash due date, certain occurrences start to emerge time and time again. For example, prior to a crash retail investors flock to the stock market, ‘cause easy money is being made. This in essence causes people to buy into overvalued companies frequently obtaining news coverage, exciting the inexperienced investors. 
An example of this could potentially be Airbnb, whereby the share price tripled from its pre-IPO share price when compared to its current share price. Did the company really get three times better since its IPO?

Although nothing is for certain, and stocks may keep on going up as they have done in recent times, we wanted to highlight some flashing red lights that people need to pay attention to. Although you are investing in a quality company, you also need to concentrate on other external macroeconomic factors that could lead to a down-trend, even though the company you invested in is beating its targets.

Investing in a company takes a lot of courage and knowledge. We feel that there is definitely a lot of people who take this for granted. Be careful, and be skeptical, and learn how to invest smartly. Be it through our content or somebody else’s. 
But incase you’re interested in following us, we are releasing 101’s on Youtube:
https://www.youtube.com/channel/UCT-LgLkojCc8CL5s46gYmSQ

To wrap it all up

We are living in a funny period where the world isn’t making much sense to anyone. We are currently in the midst of a pandemic, a lock-down and a recession, yet valuations of companies keep going up with little economic activity. Makes no sense does it?

Although we cannot tell the future, and this trend may continue for a while, remain skeptical and keep your eyes out for what has been mentioned in this article. It might save you some heartbreak.