Block 14: Economics
Now that we’ve covered business and accounting fairly in-depth, we can talk about economics. We’ve talked a lot about business, but businesses and consumers function within an economy. Even the best businesses can struggle if the economy is bad. So, as investors, we cannot neglect learning about the economy. However, focusing solely on figuring out the economy is difficult because there are so many moving parts. A lot of investors spend all of their time trying to guess where the economy is headed so that they can profit from related investments. They view it as a big puzzle that can be figured out by poring over mounds of data. We believe, on the other hand, focusing on individual businesses is a better use of an investor’s time because there are fewer moving parts to figure out. Let us explain.
There are three main factors why it is so difficult to focus solely on the economy as an investor.
First, nowadays economies are global. Trade in China affects the US and manufacturing in Taiwan has an impact on New Delhi. Globalization at its finest. Figuring out the impact of all these countries’ economic decisions is tough business in our eyes. Plus, you have the effect of global currencies as well. Some of you might be smart enough to figure it out, but not us.
Second, a large portion of the economy is affected by interest rates. Interest rates are the rates that the Federal Reserve (also known as the FED, a government agency authorized to move interest rates up and down) charges banks to borrow money. This rate then gets passed on to consumers and businesses in the form of loans and savings rates. If the FED moves interest rates up, it becomes more expensive to borrow money. And vice versa. Therefore, when the economy is doing poorly, the FED will cut rates to foster businesses and consumers to borrow and spend money to stimulate the economy. The thing is it is also tough to guess where interest rates will be in the future. No one has a crystal ball and people can form economic models to postulate where the economy will be and from there, guess where interest rates will be. However, again, there are so many factors. We would rather put our money where we have a better chance of being right.
Third, even if you have nailed the global impacts and interest rates, you still have to make an investment to profit from those predictions. In other words, even if you are a genius and are correct, what is the trade you will make to profit? Will you buy the US dollar or will you bet against banks or will you buy gold? The options are essentially limitless and who’s to say that the price of your investment will move in tandem with your hypothesis? There are many examples where economists think the markets will tank based on the data but then the exact opposite thing happens.
Instead of dealing with all of that, we choose to focus on what we can control, which is analyzing and thinking about businesses.