Investment - 4 - Dummies: Economics and Investment
Thursday, June 22, 2006
Does Economics matter for successful investment?
Most people would agree that it matters. At the very least, even a hardcore technical analyst or a quantitative analyst would concede that the major macroeconomic trends (bulls and bears) would have substantial impact on a wide range of assets, especially equities.
Let's illustrate using one simple example. Assume Ali inherited RM 1 million from his grandfather on 1 Jan 1980 and he decided to invest all his money in the equity market. He had three choices:
Option B: Invest in Kospi (Korea Composite Stock Price Index: http://sm.krx.co.kr/webeng/tong/st/sp/tn_st_sp_kp.jsp?indx_ind_cd=01)
Option C: Invest in
In hindsight, it is obvious. Choosing the legendary Warren Buffet as your fund manager would be the most wealth-amplifying choice. RM 521.5 million (refer to the table below) would put you in the top 40 richest Malaysians (using Forbes 2005 ranking, Ali would be ranked 20th).
| Option A | Option B | Option C | |
| KLCI | KOSPI | Berkshire Share Price (USD) | |
| 4-Jan-80 | 206 | 100 | 300* |
| 20-Jun-06 | 890 | 1225 | 92500 |
| Total Return | 4.32 time | 12.25 time | 308 time |
| In RM | 4.32 million | 12.25 million | 308 million |
| In RM | 4.32 million | 11.9 million | 521.5 million |
| (adjusted for currency changes)** | |||
| *estimate | |||
| **On 4 Jan 1980, RM 2.17/US and RM3.95/1000Won; On 20 June 2006, RM 3.67/US and RM3.84/1000Won | |||
Ignoring Option C, to choose between KLCI and Kospi, one needs to know the long-term economic prospect of
If Ali sought our advice in 1980, we would had told him that doing economic research could cast some light on which country would have better prospects. Though we have not look into the economic conditions in these two countries in 1980 and before that, we believe that if we examine and compare the economic data as well as the government economic policies of these two countries in the 1960s and 1970s, the probability of concluding that
To predict what would happen to South Korean economy next week or next month accurately and how this would influence the Kospi index is probably close to impossible, but to gauge the prospects of South Korean economy in the next few years based on certain economic frameworks and data and constantly update this with new data would probably produce better results. The positive correlation of the performances between an economy and its stock market in the long run is also much stronger.
It is to illustrate that the return of investing in a particular stock is far superior than investing in stock indices. Why? This is because stock indices reflect the average performance of the large listed corporations in the economy. Out of all these listed companies, if you manage to pick the company that would have the best performance (in return of equity) over a long period of time (say 30 years), you would definitely enjoy much higher returns than the stock indices.
However, putting all eggs into a basket is also more risky. A dumb decision (even an intelligent investor would trip over his own intellectual shoelaces once in a blue moon) could potentially wipe out your entire wealth. Therefore, do homework on the economic fundamentals of the company that you intend to put a lot of eggs into thoroughly is crucial as this would greatly reduce the risk. To note, if one studies the economic fundamentals of Berkshire, one would realize that even in the 1970s, Buffet had been accumulating companies with good economic fundamentals http://www.berkshirehathaway.com/letters/1979.html: strong franchise, require minimal capital expenditure, good management and record of consistently good results. Purchasing
In a nutshell, economics is crucial for successful investment. To put it crudely, understanding macroeconomics allows an investor to have a better idea of a country's economic prospects while microeconomics give you the tools to analyze the economic fundamentals of a particular industry or a company. We hope that discussing economics in Winpulse would help our readers make better investment decisions, or to acquire the right pulse to pick the Winner.
posted by winpulse @ 2:03 PM,
