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Investor 101

An Introduction to Technical Analysis

Technical Analysis is a technique or methodology for analysing securities with the primary goal to predict future price directions based on historical chart patterns.

Technical Analysis vs Fundamental Analysis

In finance most analysts group the techniques of security analysis into two broad categories: Fundamental and Technical Analysis. Whilst fundamental analysis focuses on the fundamental aspects of the actual company including its financial statements, earnings, balance sheet as well as market and sector environment, technical analysis predominantly focuses on the price graph of the stock. Many analysts, including Wise-owl, use a combination of Technical and Fundamental analysis in order to analyse and value securities.

This article is an introduction guide to technical analysis.

What is Technical Analysis?

As described above, technical analysis is a technique to analyse financial instruments such as shares, indices, ETF’s or any other security. The ‘technical analysts’ also known as ‘chartists’ mainly analyse the historical chart of a company’s stock and, based on certain techniques, attempts to predict the future direction of the stock price also referred to as the trend.

As opposed to Fundamental Analysis, the technique solely focuses on analysing the graph or chart of the stock and disregards fundamental information such as financial statements. The analyst attempts to identify certain chart patterns or trends within the stock’s graph, or any other graph, and conclusively makes predictions as to which direction the stock is likely to move. The only data needed for the assessment is the historical price data of the chart.

Technical Analysis is Based on Various Assumptions

Technical Analysis has been widely regarded as a tool or skill set that can assist an investor or trader in making investment decisions. Understanding the benefits and limits of Technical Analysis is an important step in order to become a better investor.
Technical analysis is based on several beliefs or assumptions. Some of the most common assumptions are:

Assumption 1: Stocks move in trends

A stock trend is a general direction in which the stock price is moving. The trend can be short, medium or long-term. Generally, stocks can either be in an uptrend, down trend or sideways trend.

Uptrend: An uptrend is when the general direction of the stock price is upwards. The best way to identify an uptrend is when the stock price creates higher peaks and higher lows. An uptrend is deemed broken if the latest low falls below the preceding low.
 

Downtrend: A downtrend is when the general direction of the stock price is downwards. The best way to identify a downtrend is when the stock price creates lower highs and lower lows. A downtrend is deemed broken if the latest high rises above the preceding high.

Sideways Trend: A sideways trend is when the stock price creates highs and lows at consistent price levels. A sideways trend is deemed broken if the latest high moves higher than the previous highs or the latest low moves below the previous low.

Assumption 2: Past performance is likely to repeat itself

Technical analysts try to find trends and base their forecast or conclusions on historic price movements of a stock. Based on these chart patterns coupled with the general assumption that history will likely repeat itself, they make investment decisions.

Assumption 3: The market discounts everything

Technical Analysis is based on the belief that every factor that impacts the stock price has already been taken into consideration by the market and thus is reflected in the graph. An analyst who purely focuses on technical analysis believes that the historical chart of a company provides all the information required to make future predictions. In their belief analysing the financial statements is not necessary as the market has already done that and has reacted accordingly.

Methodology of Technical Analysis

Chart

Charts are the bread and butter of Technical Analysis. Charts are used to identify and analyse patterns or trends in stock prices. Charts consist of a Y axis (vertical axis) and an X axis (horizontal axis). The X axis indicates the timeline, whereas the Y axis indicates the variable by which the security is measured, such as the price for a stock or points for an index.

Support and Resistance

Support and Resistance are important indicators in monitoring the trends of stock prices. In general terms, the ‘support level’ is a price level where a stock has consistently rebounded, this have ‘provided support’. A ‘resistance level’ is a price level where a stock has consistently failed to move past. A resistance level can be compared with a ceiling that the stock tries to break through, while the support level act like a ‘floor’.

Volume 

Volume refers to the number of shares traded during a particular period of time. This measure gauges the number of shares that traded hands for either a single stock, an index or an entire market. High volume provides greater liquidity, as more buyers and sellers are present. Generally speaking it is ‘easier’ to buy and sell shares if ther eis sufficient volume. It is often considered that it has greater signficance for a stock if it moves up or down in a high volume session, than its movements in a low volume session.

Oscillators

Oscillators is a collective term used for indicators in technical analysis. These indicators often have a set minimum and maximum level that provides analysts with information regarding the current state of the stock. When a stock hits the minimum level, it is often considered oversold and vice-a-versa. Some of the most common oscillators used are Moving Average Convergence Divergence (MACD), Price Rate of Change (ROC), Relative Strength Index (RSI) and Commodity Channel Index (CCI). 

Moving Average

Many traders use the moving average as a tool to find the right entry point to a stock. Some of the most common types of moving averages are:

a. Simple Moving Average: This method calculates an average price of a stock in the past ‘n’ trading days. This method just calculates average prices and results in a simple average line by giving equal weighting to old and new data/prices alike. This method is best to gauge the strength of a long-term trend. The SMA can show if a stock is currently trading above, below or in line ith its average price.

b. Exponential Moving Average: This moving average method places higher weighting to the most recent data and hence can be a more accurate measure to measure short-term trend patterns.

Technical Analysis: Common Chart Patterns

Apart from a basic continuation trend – where the stock forms higher highs and higher lows – there are several chart patterns that indicate – in technical analysis – either a continuation or reversal of a trend. We have summarised some of the most common chart patterns below.

Head and Shoulders

The head and shoulders pattern usually indicates the reversal of a trend. This pattern can be seen when a stock rises to a peak (left shoulder) and drops, then rebounds and rises higher than the previous peak (head) and declines again. Finally, the stock rises again, but lower than the second peak and drops again (right shoulder).  A neckline is formed by connecting the points where the stock has been rebounding. Once the head and shoulder is formed, the technical analyst believes that the stock will likely reverse its trend. The example described above, the next move will likely be downwards. A ‘Head and Shoulders’ patterns can also be seen as a reversal patterns of a downtrend.

Double Top

This a bearish reversal pattern which is made of two consecutive peaks with a moderate trough in the middle. The peaks are roughly equal and the trend resembles the letter M.

Double Bottom

This is a bullish reversal pattern which is made of two consecutive troughs with a moderate peak in the middle. The troughs are roughly equal and the trend resembles the letter W. 


Ascending Triangle

An ascending triangle is seen during the continuation of an uptrend. This is a bullish chart pattern and can be recognized with the help of two trend lines. One trend line connects a series of higher lows and another trend line that connects the highs and has proven to be a strong resistance level. This shows that the stock is consolidating after a previous uptrend and once the stock breaks above the resistance, we will likely see a continuation of the uptrend. The move past the top trend line is often called a ‘breakout’.
 

Descending Triangle

This is a bearish chart pattern created by connecting a series of lower highs with a second trend line that connects a series of equal lows which has proven to be a strong support level. Once the stock breaks below the support level we will likely see the stock moving in a downtrend.

Symmetrical Triangle

A symmetrical triangle is usually a result of consolidation and often represents market indecision. An attempt to push the stock higher through buying is met equally with attempts to pull the stock lower through selling. This action makes the stock move in the shape of a narrowing triangle forming an apex, often trading in low volumes. Technical analysts will wait until the stock breaks either to the up or downside which is called the breakout. The stock then tends to move in the same direction as the breakout.

Conclusion & Comments on Technical Analysis

Technical analysis is a useful tool that can complement your fundamental research and can assist investors and traders alike in making investment decisions. However, you need to be aware of the possibilities as well as limitations of technical analysis. At Wise-owl we use Technical analysis only as a supporting method as it helps us to backup our fundamental research or to determine entry or exit points.

As the markt is aware of the most common chart patterns we will often witness the so called ‘self-fulfilling’ chart patterns. This means that e.g. a breakout occurs as the entire market anticipates the next move and acts accordingly.

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Economics 101

Fiscal Policy: What is it and How is it Relevant to Investors?

Since the times of the great depression in the 1930s, fiscal policy has been utilised as yet another tool to influence the level of economic activity within a given nation. However not without critical debate. Economists over time have argued both for and against the fiscal policy as a tool to influence economic activity. Those that are for it argue that government intervention into the economy is necessary, especially when a nation’s economy is within the downturn phase. Whilst the latter is of the view that government intervention is not necessary for stabilising economic activity, believing that through the ‘invisible hand’, the nation’s economy would adjust itself. Despite all this critical debate amongst economists, within Australia, fiscal policy is an integral component of our economy. 

The government’s Fiscal Policy is often considered the ‘sister strategy’ to Monetary Policy, through which a central bank aims to influence the economy. You can read more about Monetary Policy here.

What is Fiscal Policy?

Put rather simply, the fiscal policy relates to the levels of government revenue and spending within the economy. The vast majority of the government’s revenue is derived from taxpayers. However, the government may also receive revenue from other sources, such as state-owned enterprises. For example, the sale and subsequent privatisation of Medibank in 2014 would be classified as a form of government revenue. Likewise, the composition of government spending may vary from country to country, however, within Australia, welfare spending makes up a big component of the budget. For example, in the 2016 budget, the federal government expects over $158 billion in welfare spending.

Fiscal Policy as a Tool to Simulate the Economy

Fiscal policy can be used to influence the level of economic activity within a nation. It is often used as a tool to stimulate the economy in times of a downturn. For example, the Rudd government in 2009 announced an over $40 billion dollar ‘stimulus package’, in response to the onset of the global financial crisis, pitting the major economies of the world into the worst downturn since the great depression during the 1930s. Likewise, fiscal policy can be used to ease an economy, when rampant inflation is a problem. This may come in the form of restrictive policies such as increased income taxes to reduce consumption and increased company tax to reduce investment.

However, what happens when government expenditure is greater than its revenue? This is commonly known as a budget deficit. Since the GFC, the Australian federal government has been running consecutive budget deficits. Why is this the case? Often governments run deficits in order to stimulate the level of economic activity during times of a downturn. So, therefore, when a government is running a budget deficit, it has adopted what is known as ‘expansionary fiscal policy’. You may wonder where the government attains further funding in running a budget deficit. In funding a budget deficit, a government would usually issue more federal government bonds, where interested investors would purchase such bonds, and through a pre-determined interest rate, investors gain a return on the bond.

Although, when government revenue exceeds expenditure, it is known as a budget surplus. Between 1996-2007, the Howard government ran consecutive budget surpluses.

Setbacks of Fiscal Policy

Whilst fiscal policy can be a useful tool in influencing the level of economic activity within a nation, it does have its setbacks. These setbacks can be highlighted when a government is running a budget deficit.

As a budget deficit is funded by an increase in government borrowing, this increases the demand by the government for credit. Theoretically speaking, as a government increases its demand for credit to fund its deficit, there could be an increase in domestic interest rates. With the demand for credit being highly related to a finite money supply, domestic interest rates may increase. Therefore, the extent of the government’s expansionary policy stance may be hindered, due to the drop in output that comes with rising interest rates. 

This phenomenon is known as the ‘crowding-out effect’, and it can be countered by central banks increasing their efforts in decreasing domestic interest rates.

Relevance to Investors: Fiscal Policy in the Context of Financial Markets

Depending on the policy stance of the government, fiscal policy could affect the share market in a number of ways. For example, if the government were to adopt a policy stance that does not encourage growth in economic activity, then we may see declines in output, consumption, and investment. With not a very supportive economic environment for companies to grow in, investor sentiment may diminish, thus reducing share market returns. Likewise, if a government adopted a policy stance that greatly encouraged economic activity, then it may correspond with an increase in investor confidence within the share market, thus increasing its returns. Rising earnings translate into higher earnings per share, thus higher valuations – at least in theory. As we know. However, seeing as the share market is based on investor speculation, it’s quite difficult to tell which direction the market would go.

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Economics 101

Monetary Policy: What is Quantitative Easing and How is it Applied?

Since the onset of the GFC, a greater emphasis has been placed on central banks around the world to stimulate a recovering global economy. While we don’t want to place excessive emphasis on the actions of central banks, investors should be aware of their purpose and available tools to influence monetary policy.

We now live in an age where, as Mario Draghi, the President of the European Central Bank (“ECB”) famously put it, central banks are willing to do “whatever it takes” to stimulate the global economic environment. The success and measure of Central Banks are debatable and their actions have posed a series of questions: How can interest rates be at, or below zero? How can the central banks adopt such a stance to monetary policy?

One such strategy is commonly referred to as “quantitative easing”. In this piece, we will attempt to explain the unconventional economic phenomenon that is quantitative easing. 

Fundamentals of Monetary Policy

In order to understand quantitative easing, we must first understand the inner workings of monetary policy. Monetary policy is used by a nation’s central bank, where through their influence over the level of interest rates and the money supply (being the sole printers of a nation’s currency), they aim to create a stable financial environment. Most central banks believe that this can be achieved through economic growth, inflation and low unemployment.

Put simply, monetary policy is a tool utilized by a nation’s central bank, in order to achieve a set of economic goals. Like most central banks, the RBA (Reserve Bank of Australia) was born out of government legislation. In turn, it also acts as the government’s bank, where it takes on the role of conducting the government’s day-to-day transactions. Transactions that are necessary for the efficient operation of government.

As mentioned previously, one of the main roles of a central bank is to conduct monetary policy in order to achieve a stabilized level of output, inflation, and maximum employment. The central bank has limited tools available and aims to achieve these goals through for example influencing interest rates or money supply within a given economy.

‘Open Market Operations’ is a process, which involves the central bank playing an active role within the market, through the buying and selling of financial assets (for example Government Bonds) from financial institutions (such as Commercial Banks).

Open market operations enable the central bank to influence the availability of credit, through having an influence on the money supply in the economy. For example, if the central bank decides to lower the interest rates, they would increase their purchases of government bonds from financial institutions (such as Commercial Banks) to increase the money supply in the market. Hence, the series of transactions between the central bank and the financial institutions within the economy will have flow on effects, in the form of an increased money supply and a greater availability of credit. The opposite would apply if the central bank sought to increase interest rates to avoid hyperinflation or slow down expansion.

In Australia, the Reserve Bank of Australia (‘RBA’) is currently adopting an expansionary stance to monetary policy, recently cutting the cash rate to a record low of 1.75% in May.

What is Quantitative Easing?

Since the GFC, central banks around the world have been aggressively lowering interest rates in order to stimulate a dampening economic environment. The modern beliefs of today’s Central Banks is that the economy can be stimulated if money is “cheap” and therefore easily available. If consumers and businesses have to pay less to borrow more money, they will likely spend it on the economy, thus increase supply and demand. However, how can a central bank further stimulate an economy when interest rates are almost at zero? One critically debated strategy is called ‘Quantitative Easing’ (or QE). 

Quantitative Easing occurs when the Central Bank of a country purchases securities in order to increase the money supply. The Central Bank essentially “creates” or “prints” new money, which is used to buy financial assets from other commercial banks. The process involves a much more active policy in buying government bonds and other such assorted securities, from a vast range of financial institutions. The idea behind this process is that the banks have now more money available, which can be issued to borrowers such as consumers or businesses. As loans become more easily available, borrowers will lend more money and spend it, thus stimulate the economy.

QE is essentially just another form of OMO. However, the difference lies is the size and scale of the program. Rather than focusing just on short-term interest rates, QE also targets long-term rates. Furthermore, the central bank is concerned to influence the total amount of reserves, thus a significant expansion of their balance sheet is required.

Quantitative Easing around the World

Since the onset of the GFC, we have seen several instances of Quantitative Easing being implemented from central banks around the world. In the USA, we saw the US Federal Funds Rate drop to a record low of 0.25% in 2009. The Fed’s asset purchasing program quadrupled their balance sheet and injected an enormous amount of money in the economy.  Similarly in Europe, we currently see rates at zero. However, one of the most peculiar of cases is in Japan, where rates have gone negative at -0.10%.

Alternative Policies to QE

There have been scholarly discussions with regards to alternative policies to QE. The most prominent being the policy known as ‘Helicopter Money’. Proposed by well-known economist Milton Friedman, this involves the central banks applying an abnormal form of monetary stimulus, whereupon they directly transfer free funds into the private sector’s bank accounts. There are numerous critics who think that the actions of the central banks around the world have gone too far with their programmes, with further discussions of ‘Helicopter Money’ further exacerbating the criticism.

Whilst there are both benefits and disadvantages to such programmes, there is one thing for sure, and that is we are living in an abnormal age of the monetary policy, where central banks are pushing their roles to the limit beyond recognition and understanding.

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Investor 101

What is the Purpose of a Share Buyback and How can Shareholders Benefit from it?

US companies in the S&P 500 have spent over U$135 billion on share buybacks during the fourth quarter of 2015, representing a 5.2% rise year-on-year.  Consumer technology giant Apple Inc. (NASDAQ: AAPL) topped the list, spending U$6 billion on repurchasing its own stock. Share buybacks are very common in Australia too. Local pharmaceutical company CSL Limited (ASX: CSL) announced a share buyback program of $1 billion in October 2015. The number of buybacks has risen substantially since the GFC and some investors may be confused and wonder what the purpose of a buyback is, why companies buy their own stock, what the impact on the share price is and how shareholders benefit from a buyback.

What is a Share Buyback?

As the name suggests, a share-buyback or a share repurchase refers to the process when a company re-acquires its own stock or, in other words, the company buys shares back from its shareholders. in Australia, the Australian Securities & Investments Commission (‘ASIC’) as well as the Corporations Act 2001, layout a number of rules and regulations for buybacks.

Why Companies Consider Share Buybacks

With an increasing number of companies announcing buybacks, it appears that directors believe that buybacks have a positive impact on the business as well as shareholders. Listed below are some of the most common reasons why a company might repurchase its own shares: 

  • Take Advantage of Undervalued Share Price: 

    A common scenario for a share repurchase is when management believes that their own shares are ‘undervalued’. Rather than keeping surplus cash in the bank, management decides to purchase shares of the company at – what they believe – a ‘cheap’ price. The buyback has two effects on the company’s stock: On the one hand, the number of shares outstanding is being reduced (we will go more into detail below) and buying pressure increases as the company is physically buying its own stock. On the other hand, by buying (often) millions of dollars of its own stock, management also reassures the market that they are confident in their own business operations, which encourages investors to buy. The market thinks that management would only buy their own stock if they believe that the value per share will increase in the medium to long-term.
  • Reduce Dilution and Increase Ownership:

    Over time companies tend to issue new shares, e.g. via capital raisings or exercise of options, which implies dilution of existing shareholders. By buying back stock, a company can reduce the impacts of dilution. Also reducing the number of shares outstanding may help increase ownership of the company’s management.

  • Enhancing Financial Ratios:

    While enhancing a company’s ratios might not be the sole reason for repurchasing shares, it is often an attractive by-product of these transactions.

    Reducing the number of shares outstanding can have a positive impact on various ratios that are tracked closely by the market.

    • Return on Asset (ROA): This ratio is calculated by dividing a company’s net income by total assets. Reducing the share capital reduces a company’s total assets and overall has a positive impact on the ROA.
    • Return on Equity (ROE): Return on Equity is expressed as the amount of net income returned as a percentage of shareholders’ equity. Hence, if a company’s earnings remain constant, reducing the total equity lifts its ROE.
    • Earnings Per Share (EPS):  This ratio is calculated by (net income – dividends on preferred stock)/ average outstanding shares. Hence reducing the overall outstanding shares boosts the EPS of a company.

How do Shareholders benefit from a Buyback?

A share-buyback is a capital management strategy that is often seen as a benefit or reward to shareholders. While investors clearly benefit from dividends, as money is deposited directly into the shareholder’s bank account, the benefits of buybacks are indirect.  As we can see from the aforementioned factors, lowering the number of shares outstanding ultimately helps to increase the share price. The company returns cashback to its shareholders and also gives investors the opportunity to capitalise on their investment. Management shows confidence in their own company which may enhance market sentiment towards the stock.

There is obviously no guarantee that the buyback will result in net capital gains as the price of a company’s stock depends on a variety of factors. However, buybacks are often considered an attractive way to invest surplus cash whilst boosting investor confidence.

When are Buybacks Not in the Best Interest of Shareholders?

While buybacks might be a sensible way for companies to use extra cash, however, in some cases, a buyback might not be in the best interest of shareholders. Listed below are a few scenarios when a share repurchase might hurt shareholders.

  • If a share repurchase is made when the company’s shares are already overvalued, management is not making the best use of the company’s cash. According to Factset, Apple paid a 13% premium to buy back its shares during the fourth quarter. Buying back stock ‘for the sake of it’ may have an adverse impact.

  • In some cases, when borrowed money is used to buyback stock, it can hurt the company’s ratings. Borrowing money for the purpose of share repurchases might drain a company’s cash reserves, which could otherwise be used during tough times.

  • Using surplus cash for purchasing its own shares might also indicate that the company’s management has no better option to invest surplus cash and the market may be disappointed as there are better opportunities elsewhere.

Conclusion

Share buybacks can be an efficient way for management to boost the company’s undervalued share price and reduce dilution, but they also allow management to show confidence in their business operations. However, as briefly outlined above, not every buyback automatically benefits shareholders. Hence it is important for investors to gauge the timing and purpose of a buyback and also look at the overall financial situation of the company.

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Investor 101

How to Open a Share Trading Account

A study from the ASX showed that over 2.5 million Australian non-investors were very keen to invest but had little knowledge on how to go about it and were confused by the information overload on the internet and in the media.

Investing in shares has historically been a great source to generate income and grow your wealth, but before getting started, you need to make sure that you know what you are getting yourself into. Before you open a share trading account you need to decide if you want to invest in shares and ensure that you understand the risks associated with investing.

Here are a few education articles that may assist you prior to making a decision:

  • What are shares? 
  • What are the risks of investing in shares?

Once you understand the terminology and risks and you have decided to begin your investing journey, it is time to open your share trading account. You have to open a share trading account with a registered broker, who will buy, sell and hold shares on your behalf. This article will address the role of the broker, the different types of brokers available, and briefly outline the process of opening a share trading account.

The Role of the Stock Broker

In Australia it is mandatory for investors to go through a broker to buy or sell shares on the stock market.

A stock broker is a financial agent who buys and sells securities on behalf of their clients. The broker acts as an intermediary between investors and the stock exchange, and charges a ‘brokerage fee’ for this service.

Even though many picture the traditional broker as a person, the term technically refers to the company with the registered license number. Thus the term ‘stock broker’ could refer to a company, a person or even just an online platform.

Full Service or Non-Advisory broker?

Historically stock brokers have always been full service ‘premium’ brokers who called their wealthy clients to execute trades on their behalf. The role of the broker was not just limited to the basic ‘execution service’, but also to provide financial advice on top. However, with the internet came an increasing number of non-advisory, online or discount brokers to the market. Before you open a share trading you need to decide what type of broker is most suitable for you.

Full Service Broker 

A full service broker generally offers comprehensive advice on buying and selling securities, provides research and tailored investment advice. Before executing a trade, the broker may also advise on the soundness of the investment. A full service broker typically charges a higher brokerage fee due to the wide range of services provided, however some broker may charge more competitive rates than others.

The full service broker is traditionally used by investors who enjoy having the ability to talk to someone, have trades executed on their behalf or even have their share portfolio managed by a finance professional.

Non-Advisory or Online Broker

As the name suggests, a non-advisory broker is predominantly used to execute trades and generally does not provide any advice on specific investments. This broker is also called a discount or an online broker.

Usually, non-advisory brokers charge lower fees and clients have to place buy or sell orders themselves. Investors are required to keep an eye on their investments and act when they believe it is appropriate. Most investors who make use of an online broker conduct their own stock research or pay a third party, such as Wise-owl, to provide complimentary research.

58% of Australians Trade Online: Study

A research report released by the ASX showed that 58% of Australian investors chose online brokering facilities, while only 31% of investors chose a full-service broker or advisor. It appears that a growing number of Australians have the desire for self-direction and control over investments.

How to Apply for a Share Trading Account

Before applying for a share trade account, an applicant must ensure that he satisfies all the requirements outlined below:

An applicant must be at least 18 years of age, have an Australian residential and postal address, and – in most cases – also have a valid email address and mobile number. During the application process the applicant has to provide a number of personal details and comply with the Anti-Money Laundering and Counter-Terrorism Financing Act 2006.

Application process:

Listed below are the main segments of a share trading application form. However, please note that the steps may vary slightly depending on the broker of your choice:

  1. Applicants are required to decide on the nature of the account:
    • Individual account: Account in your personal name
    • Joint account: Account in the name of you and someone else, e.g. your partner
    • SMSF: If you wish to apply on behalf of your Self-Managed Super Fund
    • Trust: If you wish to trade as a trust. Example: family trusts, trusts for minors, settlement trusts, and charity trust
    • Company: Trade as a company’s director or secretary on behalf of a company.
  2. The applicant is required to provide personal details, residential address, and his Tax File Number (TFN). In this step, the applicant might also be required to disclose his citizenship status, SMSF, or trust details.  Please note that additional documentation may be required for SMSF, Trust, and Company accounts.
  3. In order to open a share trading account, applicants are required to pass the identity check. Most Australian citizens and residents can be verified online, however, some applicants may be required to provide proof of identity manually (online, in person, or by post). If the applicant sends copies, he/she is usually required to get these documents certified by an eligible person (e.g. a justice of the peace, attorney, etc).

    Please note that several documents may be required for identification, however, the broker will usually advise of the requirements during the application process. It usually a requirement to provide a minimum of 100 points of ID. Documentation includes e.g. Australian Drivers Licence, Medicare Card, Australian or Overseas Passport, Australian Birth Certificate
  4. Investors need to nominate a bank account for withdrawals or dividend payments from their share trading account. 
  5. Once the application is approved you need to fund your account by making a transfer from your cash account to your new share trading account. 

Next Steps: Buy and Sell Shares

As soon as your share trading account is approved and fully funded, the next step is to buy shares and start building your portfolio. Here are some articles that may further assist you along the way:

  •  How to buy and sell shares
  • How to build a share trading portfolio
  • Investing in international shares
  • How to invest in the NYSE or NASDAQ

If you have any additional questions please do not hesitate to contact the analyst at Wise-owl on 1300 306 308 or use the live chat on the website.

Categories
Economics 101

Why is the RBA Cutting Interest Rates?

The Board of the Reserve Bank of Australia (RBA) meets 11 times per year on the first Tuesday of each month to determine changes in the monetary policy for Australia. During the May 2016 meeting the RBA decided to lower the cash rate by 25 basis points to a record low of 1.75%. Back in September 1990, the cash rate was 14% before decreasing subsequently thereafter. The questions we are aiming to address in this research piece is: What is the cash rate, how does it affect me and why is the Australian central back ‘cutting’ the rates?

What is the Cash Rate?

The Reserve Bank of Australia defines the cash rate on its website:

“The interest rate which banks pay to borrow funds from other banks in the money market on an overnight basis.” – Source: The Reserve Bank of Australia.

In simple terms, the cash rate determines the cost to borrow money. If the cash rate is high, it becomes more expensive for banks or other financial institutions to borrow money, while a low cash rate makes lending cheaper.

The cash rate impacts the cost of funding for retail and investment banks and directly translates into interest rates. The cash rate has a powerful influence on other interest rates and forms the foundation on which the interest rates in the economy are built. A change in the cash rate has a knock-on effect on the interest rates on other financial products such as deposits, mortgages, personal loans, or foreign exchange products. While the banks’ overnight cost to borrow money does not affect the average Australian, so does the interest rate for deposits or mortgages. As explained, these rates are directly correlated.

As of May 2016, the cash rate is at a record low of 1.75%, but this has not always been the case. The graph below illustrates the historical cash rate in Australia since 1990.

Image: Historical cash rate in Australia. Source: RBA

We note several periods of rising as well as falling cash rates, however overall the direction since 1990 is down trending. The policy when the central bank increases the cash rate is called ‘financial tightening’, while the policy of lowering interest rates is called ‘loosening’ or ‘loose monetary policy’.

The Cash Rate as a Tool for Central Banks to Influence the Economy

The Reserve Bank of Australia is Australia’s central bank and conducts monetary policy, issues the nation’s currency and oversees the financial system of the country.

As per the RBA’s website, the Reserve Bank has three primary targets:

1. The stability of the currency of Australia;

2. The maintenance of full employment in Australia; and

3. The economic prosperity and welfare of the people of Australia

The RBA has to create and maintain a framework of policies to ensure stable financial conditions for Australia in order to achieve the abovementioned goals. In the financial world, none of these points is guaranteed and the central banks is somewhat limited in its powers.

The RBA uses the cash rate to influence the rate of inflation and economic growth in the country. The RBA uses a range of data points from both domestic and overseas markets to assess the health of the local economy and conclusively determine the most appropriate cash rate for the current economic conditions.

The cash rate is also an important financial benchmark in Australian financial markets as well as for the currency. The cash rate is often considered to be one of the primary drivers for the strength of the currency, as a higher than expected rate often has a bullish impact on the currency and vice-versa. However, the value of a currency unit is a relative value against the unit of another currency in the foreign exchange market, thus there are a range of factors that influence the strength.

Why is the RBA Cutting Rates in 2016?

During the past few years the Reserve Bank has consistently lowered the benchmark cash rate. The RBA believes that ‘easing monetary policy’, meaning lowering the cash rate, creates an accommodative environment for the local economy. The RBA believes that the lower cash rate translates into a lower currency, and thus supports demand which will eventually support inflation as well as economic growth.

The Impacts of Low Interest Rates on Australia

Falling interest rates affect everyday Australians in a number of ways. Generally, a drop in interest rates makes mortgage interest repayments more affordable and thus encourages Australians to lend money. On the other hand, a lower cash rate discourages saving as Australians earn less interest for money ‘sitting’ in the bank. Indirectly, the RBA aims to encourage spending which then translates into increased economic activity.

Alternative investment assets should technically benefit from low-interest rates as savers get less money in return for their cash. Therefore, low-interest rates encourage Australians to invest in assets that have historically generated higher rewards, such as equities.

In theory and as per ‘Economics 101’, lower interest rates mean higher stock market returns. However, history has taught us that this may not always be the case as a range of factors impact stock market valuations. Analysts often scrutinise the language that the RBA uses in their monetary policy statements to find any clues on future monetary policy. The overall economic conditions, stock market valuations as well as overseas events are just a few factors that impact stock prices, thus investors should not exclusively focus on central bank policies.

Categories
Economics 101

Economic Indicators: Purchasing Managers Index (PMI)

The Purchasing Managers Index (PMI) is an index that measures manufacturing activity in an economy, based on surveys conducted on a specific set of purchasing managers on a monthly basis. The PMI is a leading indicator of economic health in a particular sector or the economy as a whole. The Purchasing Managers Index is used to measure manufacturing activity by many countries worldwide. The Australian Industry Group measures the Manufacturing PMI in Australia. 

Manufacturing PMI

The Australian Manufacturing PMI measures the manufacturing activity based on seven sub-indices and eight sub-sectors. Any reading above 50 indicates an expansion in manufacturing activity and any reading below 50 indicates contraction.

‘New orders’ is one of the most important sub-indices, and is generally considered a leading factor to changes in the economic output. A rise in new orders usually indicates an expansion in demand for the respective sector. The remaining sub-indices include Production, Sales, Exports, Deliveries, Stocks, and Employment.

Outlined below are the eight sectors that are gauthe Manufacturing PMI:

1. Food and Beverage: This sector measures the manufacturing activity amongst food, beverage and tobacco producers. This is the largest manufacturing sector in Australia and some of the external factors that may impact the output are currency movements, imports and exports.

2. Textiles, Clothing, Furniture and other: This is a relatively small sector and is mainly affected by retail demand.

3. Wood and Paper: The relatively small wood and paper products sector is affected by demand from the food and groceries sector and demand for wood products from the building industry.

4. Printing and Recorded Media: This sector is affected by technology change, import competition and fluctuations in currency. 

5. Petroleum, Coal and Chemicals: This sector covers manufacturers of pharmaceutical products, toiletries and health supplements and other construction materials such as paints and adhesives.

6. Non-Metallic Minerals: This sector gauges the demand for products such as tiles, bricks, cement, glass and other engineering construction and automotive supply chain parts. 

7. Metal Products: Gauging the change in demand for large metal products, this sector is affected by demand from the energy and resources sectors.

8. Machinery and Equipment: This sector measures the demand for automobiles and is generally affected by local currency fluctuations.

Purpose of PMI

Generally, the purchasing managers have early access to data about their company’s performance, which enables this index to be used as a leading indicator of overall economic performance. The PMI also allows economists to identify the ‘boom-bust’ business cycle, and assists analysts to see whether the demand and supply imbalances are readjusting within the sub-sectors and measure the effect on consequent changes in prices for each sector. The PMI is not revised after publication, unlike the other official data. Moreover, the PMI is produced using the same methodology across all countries, enabling accurate international comparisons.

Categories
Economics 101

US Stock Market: How to Invest in the NYSE or NASDAQ

There are various stock exchanges in the USA, but the most known exchanges are arguably the New York Stock Exchange (“NYSE”) and the NASDAQ. These exchanges are two of the largest and most prestigious exchanges in the world. The NYSE regularly tops the list in rankings which are based on total market capitalisation or value of shares traded.

Similar to Australia, the overall performance of companies listed on these exchanges is often measured as a group to provide investors with a broad reflection over the overall stock market performance. Some of the most quoted benchmark indices are the S&P500, the Dow Jones Industrial Average (“DJIA”) or the Nasdaq 100. Many Australian investors read about the S&P500, the Dow Jones, Nasdaq or even the Russel 2000 on a daily basis in the business news of their local newspaper.

While all stock exchanges serve the common purpose of facilitating trading securities, they differ in nature. Even though investors purchase shares through their broker, it is important to understand the terminology and distinguish features or classifications of overseas markets. With a vast number of Australian brokers offering access to overseas stock exchanges, the purpose of this research note is to provide Australian investors with a brief overview of the US stock market and how you can invest in overseas equities. 

The New Stock Exchange – The Most Prestigious Stock Market

Established in 1792, the New York Stock Exchange is the oldest, largest and one of the most renowned stock exchanges in the world. This stock exchange has more than 3200 listed companies and is often referred to as the “Big Board”. As opposed to fully automated exchanges such as the ASX, the NYSE uses floor traders to facilitate transactions.  Until 1995, the exchange relied solely on the so called ‘open outcry’ system. The open outcry method is a system where dealers and brokers shout their bids and contracts aloud in order to execute a trade. While more than 50% of the trades are now performed electronically, customers can also send their orders to the floor through the public outcry system.

Some of the most known and largest companies are listed on the NYSE such as JP Morgan Chase and Co., Disney, Nike, General Electric, Johnson and Johnson, Alibaba Group Holdings or Walmart. 

The NASDAQ Stock Market

The NASDAQ Stock Market or often simply referred to as “NASDAQ” was founded in 1971 and is currently the second largest stock exchange in the US and the world, by market capitalisation (as at April 2016). Approximately 3100 companies are listed on the index and roughly 2 billion shares are traded on a daily basis. The NASDAQ is an electronic trading exchange and rather a communication system than a physical stock exchange. Orders are being executed by the online execution system or market makers.

Most US tech giants are listed on the Nasdaq such as Microsoft, Apple or Google and thus the technology sector makes up for nearly half of the industry breakdown. 
 
  

Three US Indices: S&P500, Dow Jones, and Russell 2000

Now let us have a brief look into the characteristics of three of the most commonly followed indices:

Standard and Poor’s 500

The Standard and Poor’s 500 indexes, often referred to as the ‘S&P 500’, is one of the most commonly followed equity indices in the USA, and is generally considered as one of the best representations of the US stock market and (to a certain degree) a bellwether of the country’s economy (read hear about the correlation of GDP growth and stock market returns). The S&P 500 index was launched on 4 March 1957 and currently consists of 500 companies with a total market capital of USD 7.8 trillion (as of April 2016).

The S&P 500 comprises of the 500 largest stocks, usually listed on the NYSE and Nasdaq Composite stock exchanges. These stocks are chosen based on specific criteria such as market capitalisation, liquidity, or their weighing on the industry. According to Standard and Poor’s, this index captures approximately 80% of the total market capitalisation of the US bourse.

Below is a table comprising of the largest companies by index weight (this data is as at 04/2016. No guarantee is made for the accuracy of this data).

CompanySymbolSector
Apple Inc.AAPLInformation Technology
Microsoft CorpMSFTInformation Technology
Exxon Mobil CorpXOMEnergy
Johnson & JohnsonJNJHealth Care
General Electric CoGEIndustrials
Facebook Inc (A Class)FBInformation Technology
Berkshire Hathaway (B Class)BRK.BFinancials
Wells Fargo & Co.WFCFinancials
Amazon.com IncAMZNConsumer Discretionary
Procter & GamblePGConsumer Staples

Dow Jones Industrial Average

The Down Jones Industrial Average is one of the oldest gauges in the world, often abbreviated as DJIA, and consists of the 30 largest companies listed in the US. Inclusion is based on a number of factors such as market capitalisation or volume. Along with the S&P 500 index, the DJIA is one of the most widely tracked indices in the world.

Russell 2000

The Russell 2000 is one of the most quoted benchmark indices for small capitalisation or “small-cap” stocks. This index comprises of the smallest 2000 companies listed on the U.S. stock exchanges such as the Nasdaq or the NYSE. 

What are the advantages of investing in US stocks?

Considering that US stocks have achieved outstanding returns over the long-term, it is often believed that Australian investors could benefit from “international diversification”. An increasing number of brokers offers easy access to international markets as there are a number of advantages for investing in the largest stock market in the world:

  1. Diversification: As we can see from the charts above, the industry breakdown of overseas markets may differ from the local market. Overseas markets can offer exposure to industries that are underrepresented on the ASX. In the US, companies from the information technology sector have a stronger weight on the overall market, currently around 20%. For example, this sector only has a 0.8% representation on the Australian Securities Exchange (as of April 2016) as investors are left with very few options to invest in IT.

  2. Access to the largest companies in the world: Some of the largest companies in the world are listed on the US stock exchange. To give you an idea of the extend, the market capitalisation of the largest stock on the S&P500, Apple Inc. (AAPL) is 8 times larger than the market cap of Commonwealth Bank of Australia (ASX: CBA). Many of the most known brands are listed in the US such as Disney, Nike, Amazon, or Google.

  3. Prestige & Regulation: The companies that are listed on the US exchanges are subject to the regulations of the US Securities and Exchange Commission (SEC). Furthermore, in order for a company to list on the NYSE or the Nasdaq, they are also required to comply with high listing requirements as it is required to comply with the distribution standards of the respective stock exchange. For example, A company’s share price must be above $4 in order to list on these stock exchanges.

What are the risks of investing in US stocks?

Investing in any type of security comes with a certain degree of risk and US stocks are no different. Click here to read our education article about the risks of investing in shares. The potential loss of capital is the greatest risk when it comes to investing, however, there are additional risks that need to be considered before investing in the US market (or overseas in general)

  1. Foreign exchange impact: Investing in overseas equities is subject to currency exchange fluctuations. As your holding is in the nominated foreign currency, the value in Australian Dollar (AUD) terms may fluctuate. Unfavourable foreign exchange movements can have a negative impact on one’s net value of a foreign investment. For example, if the AUD appreciates against the USD, the foreign investment that you are holding in USD would have declined in AUD terms (if you exchange it back into the local currency) and vice versa.

  2. Less understanding: While many investors may have a fairly good understanding of the Australian economy and Australian listed companies, they are often not able to fully comprehend overseas markets. The underlying fundamentals of US companies or the economy, in general, is quite different and often investors don’t understand overseas markets as much as their own domestic market. In addition, while these markets operate in different time zones, the price-sensitive announcements may be made while you are asleep which may limit your ability to take action.

  3. Tax Implications with Dividends: Australian residents often enjoy the benefits of franking credits for dividends distributed by ASX listed companies. There may be additional tax implications for overseas holdings that could impact net returns. For tax advice, we recommend you talk to a qualified financial planner or accountant.

How to invest in US Stocks?

Nowadays overseas stocks have become increasingly accessible for Australian investors. There are a number of domestic brokers that offer access to some of the largest stock markets in the world, such as the US market.

The first step is to check with your broker if they support trading in international shares. If an investor has an online share-trade account, they can often simply open an international trading account with their respective brokers online.

Find below a list of some of the most common brokers an investor can choose from here in Australia. (Please note that this list is not conclusive as there may be other providers available. Please consult with your financial planner firsty before opening an international share trading account. This list is for information purposes only, Wise-owl does not get any commissions from these links.)  

  • CommSec: Click here to access the website

  • Nabtrade: Click here to access the website

  • ANZ: Click here to access the website

  • Intelligent Financial Markets: Click here to access the website 

  • CMC Markets Stock Broking Limited: Click here to access the website

As soon as your application is approved and your account is funded, you can purchase international stocks, just as you would purchase Australian equities. Make sure you infrom yourself of trading hours, as order can only be executed while the market is open. If you have additional questions, feel free to call one of the advisors here at Wise-owl on 1300 306 308.

Investing in US Exchange Traded Funds (ETFs)

Put simply, an ETF (Exchange-Traded Fund) is a fully tradeable security that tracks the performance of a basket of securities, commodity or other financial instruments. ETF’s are usually issued by a bank or some other financial institution, which offer investors with diversified exposure to commodities, stock indices, currencies, and more.

For example, in the US, one of the most traded ETFs is the SPDR S&P 500 ETF, which tracks the movements of the S&P 500. Investing in ETF’s may increase diversification, as you are able to invest in a range of assets.

Often investing in ETFs is easier than picking individual stocks, hence Australian investors who want to invest in the US, could consider investing in an Exchange traded Fund.

Investors can choose from a variety of ETFs. Listed below are a few ETFs that offer Australian investors with exposure to the US stock market. (Please note that this list is not conclusive as there may be other providers available. This list is for information purposes only, Wise-owl does not get any commissions from these links.)

  • Blackrock: Click here to access the website 

  • ANZ: Click here to access the website 

  • Vanguard: Click here to access the website
     
  • State Street Global Advisors: Click here to access the website

  • BetaShares: Click here to access the website

  • Platinum Asset Management: Click here to access the website

Where do I find Research for US Companies?

The internet makes it possible to find information for any listed US company just as you would find commentary for Australian companies. Sources include the company website, newspapers, online editorials or stock forums. However, the challenge is to filter the advice you are getting. It is easy these days to get advice for everything, but it is not easy to get ‘good’ or ‘well researched’ advice.

Since 2015 Wise-owl offers stock tips for international equities as well. We focus on the largest companies in the U.S. and European stock markets with the primary focus on capital growth and dividends.

Members can click here to view our international portfolio and non-members can click here for a free trial in order to receive our international stock picks.

Please note that Wise-Owl does not receive any commissions from third party companies that are listed in this report.

Categories
Investor 101

How to Lookup ASX Announcements

According to Listing Rule 3.1 under the Continuous Disclosure Obligations laid out by the ASX, any company that is listed on the ASX has to disclose company news in the form of ‘ASX announcements’. The rule states that all information that a layman might expect to have a material effect on the company’s share price, have to be released to the market immediately.

Why Look Up ASX Announcements?

Investors search for company announcements for various reasons. When you do your own research, we advise you to go through a company’s announcements to understand the company’s history, balance sheet, corporate activity, or one-off events. Unless you buy a stock for technical reasons (read here our introduction to technical analysis), you’ll have to understand the company’s business model to a certain degree and the announcements are a good place to start. As the ASX keeps a record of all announcements, you will also be able to compare the historical financial performance for any given period. Another reason to look up a company’s announcements might be to find out why a stock you are holding has made a significant move to the upside or downside. Significant share price movements are often linked to price-sensitive announcements.

Many average retail investors might be confused about finding relevant factual data about the companies they are interested in. They might finally resort to reading the business section of the major tabloids or check the company’s website as an avenue for updated information.  However, the newspapers are sometimes limited in nature, often reporting on only the major ‘blue-chip’ companies or including personal opinions in the article. Investors who are doing their own research might be overwhelmed by the numerous opinions on the web.

3 Ways to Look Up ASX Announcements

Find below a few options of where to search and find ASX announcements.

1. ASX Website
Many investors are unaware that they can keep themselves updated about operational changes of any ASX listed company. This information isn’t difficult to obtain, as everyone can access it by simply navigating to the official ASX website www.asx.com.au. They can search for the information of any ASX company of their choice and view past company announcements. The ASX website is the best place to look for announcements as they are released in real-time.

Today’s announcements can be found here: http://www.asx.com.au/asx/statistics/todayAnns.do

The website automatically displays the latest announcements, sorted by the time of publication. Simply save this link in your web browser so you can access it whenever you want. In order to view new announcements, you have to refresh the page regularly.

Additionally, the ASX website also denotes to the reader the ‘price-sensitive announcements’ indicated by a red ‘$’ beside the announcement. These announcements are usually more important, and could potentially have a substantial impact on the company’s share price.

These ‘price-sensitive announcements’ vary in nature. They could be the release of earning results for a given time period, the appointment of a new CEO or a director, or some unforeseen event occurring within the business’s operations (such as BHP’s recent Samarco Dam Disaster).

Historical announcements of a particular company can be found here: http://www.asx.com.au/asx/statistics/announcements.do

Simply choose the ticker code of the company you want to look up and select the timeframe. Tick the second box and select “2016” if you want to see all announcements released in 2016.

View the screenshot below for illustration purposes

2. On your Broker’s Website
Many online brokers have built-in features to view and read company announcements. The largest online brokers in Australia usually have a section dedicated to announcements in their membership portal. If you can’t find this section or you are unsure if your broker offers this feature, we advise you to talk to your broker and find out if and where you can read company announcements. Often there is a 20-minute delay with these publications.  

3. On the Company Website
Every listed company has a section on its website dedicated to investors. You can read media released stock information, annual reports, key dates, or the “Corporate Governance” statement. Jump onto www.google.com.au and type in the name of the company you are looking for. Usually, the first result is the company website, and from there you should be able to find all announcements.

Categories
Economics 101

Economic Indicators: Inflation

Ever heard childhood stories from your parents or grandparents, talking about how they could visit the local Milk Bar and purchase a big bag of lollies for a couple of cents? I know I have heard it time and time again. While this is a very common story, it discusses a very interesting economic phenomenon that affects households and businesses every day. The few cents that could buy a bag of lollies during our grandparents’ generation, cannot purchase anything in today’s economy. The same bag of lollies will now have to be purchased at much higher prices. This phenomenon is called inflation.

What is Inflation?

Inflation refers to the sustained increase in the prices of goods and services from year to year, resulting in the decline in purchasing power of a country’s currency.

Some of the root causes of inflation could be:

  • Rapid increases in aggregate (overall) demand, higher than the increase in the supply of output. These are called demand-pull inflation pressures.
  • Increases in the costs of production or cost-push pressures, wherein higher production costs push the prices of goods sold. This includes one-off price shocks in certain commodities. Example: Australia witnessed a major price shock in the ’70s when OPEC curbed oil output, where the inflation rose to 20% a year. 

Excessive inflation can have varying effects on households and businesses such as a decrease in purchasing power, to what some economists would argue, an inefficiency in the money value system.

In the past 100 years, there have been severe cases of hyperinflation, meaning rapid increases in the prices of goods and services. One of the most prominent cases being in Zimbabwe, where at its peak in 2008, prices were doubling almost every 24 hours. Zimbabwe’s currency became so worthless, that in 2009, it was no longer in circulation. Instead, the country’s people opted to use a multitude of currencies, such as the South African Rand, USD, and the Euro.

Luckily, Australia hasn’t had such severe cases of inflation, where over the last 10 years, we have been able to achieve our target rate of 2-3% per annum.

How is Inflation Measured?

Although it may vary around the world, most countries use the CPI (Consumer Price Index), including Australia, as the main indicator of inflation levels. The CPI measures inflation by constructing a basket of around 100,000 goods and services that are weighted according to their importance to the metropolitan household.

Whilst the CPI does act as a relatively good indicator of inflation, it does have its limitations. As this ‘basket’ of goods and services is essentially fixed, it may over-exaggerate the increase in the price level, as it doesn’t account for the technological improvements in certain goods and services. For example, whilst smartphones are much more expensive than what mobile phones used to cost over 10 years ago, their functions go beyond just being a form of communication. Smartphones can be a gaming platform, business tool, or even simply an electronic encyclopedia, with their ease of access to search engines such as Google.

However, when analysing price changes, Central banks are not limited to simply one measure of inflation in the economy. Central Banks may also use the Core Inflation measurement, as an indicator of underlying price trends in the economy. Core inflation aims to take out the ‘one-off’ price shocks to the economy, which may either over-exaggerate or underwhelm price changes.

For example, when Cyclone Yasi hit Queensland in 2011, a lot of banana crops were destroyed, very noticeably decreasing the supply of banana’s, coinciding with a significant increase in prices to around $3 a banana. Whilst this price shock may hay have most likely coincided with slight increases in Headline Inflationary figures, there would be no change in Core Inflation, as it eliminates those ‘one-off’ price shocks that may lead economists and analysts astray.

Therefore, when measuring the levels of inflation in the economy, central banks, economists and analysts alike utilise several measurements of price changes in the economy, in order to fully understand the bigger picture.

Inflation’s Link with GDP

Inflation has an interchangeable link with the prime indicator of economic growth within a country, GDP (Gross Domestic Product). Within the ‘boom’ phase of the business cycle, where actual GDP is exceeding potential GDP, inflation is usually above the target rate. Likewise, during the ‘trough’, or recessionary stage of the business cycle, where actual GDP is below potential GDP, the inflation rate would usually be below the target rate. As was the case with the US economy during the GFC, wherein 2009, GDP growth and inflation were both negative.

GDP also acts as an indicator of society’s living standards (with many limitations). However, growth in inflation can also over-exaggerate GDP, and thus living standards. For example, Nominal GDP is the final value of all goods and services produced in an economy over a given period, at current market prices. If hypothetically in one year, inflation was quite above target, this would over-exaggerate the growth in Nominal GDP. However, this is not reflective of the society’s current living standards.

That’s why in analysing economic growth, analysts and economists alike prefer to use Real GDP, which provides a relatively accurate picture of a country’s economic growth after removing the effects of inflation.

Inflation’s Link with the Stock Market

The link between inflation and stock returns has often been discussed, with a multitude of results. In times of higher rates of inflation, corporate profits in some sectors may be lower, as inputs are higher, which in the short term, would further worry consumers. However, higher rates of inflation could possibly benefit some firms producing goods and services that have relatively inelastic demand, as consumers are not very reactive to price changes in certain goods and services.

Although, a study conducted on the US S&P 500 showed that, generally stock returns were higher when inflation is stable, with higher inflation coinciding with increased stock market volatility.

Can Inflation be Controlled?

Economists often argue and debate about whether inflation can be controlled, or should be left alone, in order to correct itself. However, since the GFC, central banks are making collective efforts in reaching their respective inflation goal.

This can be particularly seen through most developed economies’ central banks, such as the ECB (European Central Bank) and the BOJ (Bank of Japan), where they have adopted very accommodative monetary policy stances. Recently Japan succumbed to Negative Interest Rates, in order to avoid a rapid decrease in the prices of goods and services in an economy, otherwise known as deflation.