Economic analysis is a critical part of investing successfully.
Investing without one is the financial equivalent of driving to your destination on the other side of the country without a map (ok…or without a GPS).
Analyzing an economy is relatively simple and something you can (and should) do yourself.
It really is. You see, most economists, forecasters, and “experts” in the mainstream financial media make it far harder than it has to be. They will focus on the every weekly report and the tiny details and then do what Wall Street always does – extend short-term trends indefinitely to the future.
However, one GDP, consumer spending, or housing sales report does not tell the entire story about the state of an economy. And to overweight one data point is one of the biggest mistakes you can make in economic analysis. But they all do it. And if you’re not doing your own economic analysis, you’re likely paying a price for their mistakes.
You don’t have to be in that position. And the time to stop paying for their errors is now. Here’s how to get started completing your own economic analysis to better guide your investment decisions.
Economic analysis, by definition, is an analysis of a given population’s ability to produce goods and services.
One example of a complete economic analysis is an individual GDP report. These reports show how much an economy is producing over a certain period.
But when it comes to using economic analysis for investing, it’s the trend that matters. Because what’s really important for investors is the future state of the economy and what it will mean for corporate earnings and not where it is right now.
The main portions of an economic analysis that will be focused on guiding you to make better investments can be broken down into three different categories: government policy, relative health, and future growth prospects.
Economic Analysis of Government Policies
One of the major factors affecting an economy is government policy.
Some of those factors include unemployment rates, tax collections, electricity consumption, and housing prices and sales. They are great indicators of the health of an economy.
All of those factors are impacted greatly by government. So government actions like tax rates, regulatory proposals, and others should be a part of your analysis.
Also, a major point not to forget about economic analysis which your editors are often laughed at (only in the short term of course), is the long-run trend of all free economies.
The trend is always up in the long run. It’s a natural instinct of people to be driven to create wealth and improve their own economic standing despite harmful government policies and interference.
Relative Economic Health through Economic Analysis
Investment opportunities start to appear through economic analysis when investors advance into examining the relative health of the world’s many different economies.
A classic example of economic analysis uncovering excellent investment opportunities would be one of the best performing stock markets of the post-credit crisis world.
That’s Colombia. Yes, the South American country that was more known for its drug industry than any other.
The Colombia boom story started with the race for natural resources which have been going on for nearly a decade. As you know, the tremendous economic growth of China and the rest of the emerging world economies have pushed demand for natural resources far beyond the limits of past production. The result was much higher prices for commodities – especially oil and metals – and a global race to find and develop new sources of those increasingly valuable natural resources.
Many economies of the world benefited greatly. That all stopped during the credit crunch of 2008.
But it didn’t stop for long. And one of the big winners out of the commodity (re)boom was Colombia.
Colombia’s opened up its vast natural resources – like its oil, gold, and copper – to the development of many western companies with the capital and know-how to turn reserves of oil, copper, and gold into money, growth and jobs.
The Colombian economy boomed.
Comparative economic analysis led your editor to describe Colombia at the time this was all beginning as “digging its way to the top.” And early investors could have doubled their money in a little over a year’s time by just buying the entire Colombian stock market.
Comparative economic analysis allows you to spot booms of all sizes throughout the world and capitalize on them as an investor.
Comparison of Economic Growth and Policy through Economic Analysis
As an investor, economic analysis should be focused largely on the relative performance of different economies around the world and how the markets are reacting to each.
For example, the best contrarian investment opportunities are found by contrary investors looking for “basket case” economies.
These truly rock bottom investment opportunities are found in economies which have gone through major economic upheavals recently and during the periods when the outlook for economies is bleakest.
Everyone is selling. No one is buying. Asset prices are low and sentiment is lower. Contrarian investors see these opportunities as great chances to find the best investments with the least risk and the highest rewards.
Remember, the long-term trend of all free market economies is up. And history has proven time and again periods of economic despair are often short-lived. Meanwhile, periods of prosperity tend to be long and significant. That’s why the world is far wealthier today than it was just a few years ago and the biggest gains go to the bravest investors willing to buy when no one else is willing.
Positive economic analysis can and will lead you to these truly great investment opportunities.
Major Factors of Economic Analysis
Finally, there are many, many reports of economic indicators and data produced throughout the world every week that have a place in any fundamental economic analysis.
Frankly, there are far too many for any one person to track.
If you’ve followed the financial media for any length of time, you know there are usually at least three “major” economic reports released every week and dozens of smaller ones. Each report of new economic data will be analyzed extensively. They will impact the day-to-day market moves as well.
There are, however, a handful of economic data points which give the most accurate indication of economic health and provide you with the base of economic analysis:
- GDP Growth
- Consumer Spending
- Manufacturing Activity
- Unemployment Rates
- Government Spending
- Housing Prices
- Electricity Consumption
- Corporate Earnings
These are the main areas where you’re analysis of economic data will be centered.
And by keeping your focus on these major indicators, you’ll be able to form much more accurate economic analyses without having to incorporate all the news.
And again, the economic trends revealed by your synthesis of the important economic data into your own economic analysis will help make you a much more successful investor.
Executive Editor, Contrarian Insights
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