Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

Hello everyone, welcome again to Sister Round Reading, today we continue to read this book, "The Long-Term Magic of the Stock Market".

In the previous article, we discussed "what kind of stocks are more likely to generate excess returns", and the answer is: from the market capitalization, small-cap stocks have higher long-term returns; secondly, stocks with high dividend yields, low P/E ratios and low P/N ratios have higher future returns; thirdly, stocks with low turnover rates have higher yields.

Today the author takes us through a look at the impact of the economic environment on stocks.

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

In 1950, President Truman boldly predicted that by the year 2000, the income of American families would quadruple from $3,300 to $12,000, and many people cheered at the time, but later it became clear that this goal was too conservative, because in 2000 the real income of middle-income American families reached $41,000, not a quadrupling, but a nearly 14-fold increase.

What a cheerful story! However, this is not the case. At 1950 prices, $41,000 in 2000 could only buy less than $6,000 worth of goods, which means that nominal income did increase 14 times, but real purchasing power only doubled, which is the result of inflation.

In 1931, Britain announced its departure from the gold standard system, signaling the end of the gold standard system that had existed for more than 200 years. A year and a half later, the United States also announced the abandonment of the gold standard system, and then the world began to implement the paper money standard system. The shift in monetary control from gold to government under the paper standard system increased the ability of central banks to provide liquidity at will, which led directly to inflation. A simple understanding of inflation is that there is actually more money and less goods, and it leads as a direct consequence to higher prices, resulting in people having less money on hand. So continued inflation is a huge erosion of our wealth, and as in the story above, years later, it looks like the money is unchanged, but the things you can buy with it have shrunk considerably.

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

However, while the paper money standard led to inflation, the ability of the central bank to provide liquidity was important to the economy, especially to the value of stocks, which cannot prosper without liquidity and a style credit environment.

We say that in the long run, stocks are the only investment product that can outperform inflation. Because stocks represent real assets, inflation is actually beneficial to the stock market, but this seems to contradict the concept of "high inflation is negative for the stock market". In fact, what the stock market is afraid of is not inflation, but the various control policies adopted by the government in the face of inflation, which include raising market interest rates to suppress inflation. Market interest rates and stock market performance show an obvious negative correlation, that is, the stock market will rise if interest rates are lowered and fall if interest rates are raised. There is also a general perception in the market that when the market is in a cycle of easy money and easy credit, the stock market generally does not perform badly.

So, for the public, the only way to hold on to wealth is to invest.

Then in everyday investment, we always hear the term "economic cycle". The economic cycle is simply understood as the four seasons in life, spring, summer, autumn and winter are always cyclical, except that the economic seasons are not distinct in time, that is, there is no rule, when the winter will leave when the spring will come, no one knows. If investing in stocks is like planting crops, then it is important to wait patiently for the spring sowing and autumn harvest.

In the public perception, it will feel that the stock market is good when the economy is good, and the stock market is bad when the economy is bad, so most people like to invest in the stock market when the market is good, is this the right investment?

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

The authors examine the response of the S&P 500 to the economic cycle over the period 1871-2012 and show that the stock market does not perform in tandem with the economic cycle, but rather reacts ahead of it, that is, it begins to fall before the recession and rises sharply just as the economy begins to show signs of recovery. The simple understanding is that if you invest in stocks according to the economic cycle as the market already perceives it, you are likely to be too late to get out of the market when it is falling and too late to catch up when it is rising.

The authors say that to gain excess returns through the economic cycle, it is important to predict the inflection point of the economic reversal, which is not a skill that ordinary people can master, and even economists are rarely able to make accurate predictions. He also studied the predictions made by economists during the major recessions in history, and the results showed that basically no one could predict the economic inflection point with complete accuracy, with a minimum error of about 1 year and a large error of 3-4 years. If the error of 1 year, in the Great Recession of 2007-2009, the S&P 500 fell by 40%.

So, the wish is very good, the reality is very cruel, by predicting the economic inflection point to obtain excess returns this road, simply can not go.

After talking about the impact of economic cycles on the stock market, the author next mentions the impact of major world events on the stock market, such as wars, natural disasters, and financial crises. Most people are very fearful of such big events, such as this Russia-Ukraine conflict, which made many investors, who were just eating the crowd, flee the market in a panic. So does every big event affect the stock market?

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

After examining 200 years of historical data, the authors found that of the 145 major market movements, only 30 were accompanied by clear major world political or economic events, such as World War II and the September 11 terrorist attacks, while most of the sudden plunges could find no cause at all, such as the 1987 stock market crash, which set a record for a one-day decline of 23%, but could not be linked to any major event to produce a connection.

And regarding the impact of war on the stock market, the authors find that despite the fact that the U.S. has spent one-fifth of its time in war since 1885, according to the data, the nominal returns of the stock market have been essentially similar in both wartime and peacetime. Only when inflation is factored in do the peacetime years have a return advantage because of the inflationary risks associated with war. So most world events may only have a large impact on the stock market for a very short period of time, but they do not affect the stock market's long-term return returns.

In addition to unpredictable world events, regularly disclosed economic data, such as economic growth, employment reports, and inflation reports, can also have some impact on short-term stock markets. But usually the market does not react directly to these data, but to investors' expectations. That means it doesn't matter if a data is good or bad, it depends on how investors think about it. If the data itself is good, but does not meet investors' expectations, then good news can turn into bad news because of disappointment; if investors are too pessimistic, then even if the data is not pretty, it can turn into a major positive. So while economic data is certain, people's emotions are elusive, and relying on economic data to invest remains unreliable.

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?

Of course, there are some common factors that we can still learn from, such as high inflation is definitely negative for the stock market, while wide money is definitely good for the stock market. The author's intention in writing this section is to tell ordinary investors that investment is a long-term thing, and there are many factors affecting the stock market, and it seems that there are many opportunities to gain excess returns, but after analysis you will find that these so-called opportunities for ordinary investors, in fact, are "flowers in the mirror and the moon in the water", see but The safest way is still to hone your mind and invest for the long term.

Well, the above is today's share, I am round sister, follow me, and you read the financial management together.

Stock Market Long-Term Magic 05: Monetary Policy? Economic Cycle? Who really affects the stock market?