Words carry a lot of weight. According to Robert T Kiyosaki, author of the bestselling book Rich Dad Poor Dad, words can make you rich. The words he refers to are financial words. He has been on a crusade for years telling people that, if they want to become millionaires, they need to expand their vocabulary.
They need to know what ‘good debt’ and ‘bad debt’ is. They also need to know the basics of what makes an asset an ‘asset’. If you know more financial words, and you increase your financial literacy, you’re probably more likely to do well financially.
Words can also carry enormous weight. That’s why officials, like parliamentarians and central bankers, need to be careful with the way they craft their words.
On 27 August, Janet Yellen, head of the Federal Reserve, expected her words to send US share markets down.
In her speech she warned that the case for raising US interest rates ‘has strengthened in recent months.’ But instead of pulling money out of the market, investors continued to pump capital into stocks.
Equities and interest rates
Everyone knows what interest rates are. They’re rates at which you can borrow or store money. You can borrow money to buy a house, car or any other desired good. But interest rates don’t just affect your mortgage or savings account.
A swing in interest rates, up or down, can have big implications for businesses and the share market.
Just like regular people, companies also like to borrow money. So if interest rates are high, it costs more for businesses to borrow. But if interest rates are low, it’s ‘cheaper’ for businesses to borrow, as they’ll have to pay back less interest.
With Yellen hinting that there’s a case for rising interest rates, she’s implying it could become more costly for businesses to borrow money. So it would cost more to fund projects and various other investments. Boiling it all down, it would become more costly to do business.
An increase in interest rates can leave households with less disposable income. If bills go up, then you’ll be less likely to spend on discretionary items. So it not only costs businesses more to borrow money, but their target market might end up spending less if interest rates go up.
What is the stock market made up of? Businesses. Therefore, if it costs more to borrow money, and the public is less willing to spend, profits will likely fall, bringing down shares with them.
And that’s why, when Yellen hints at rising interest rates, it was a surprise that US markets actually rose instead of falling.
Stocks that do their own thing
If the Fed does in fact lift interest rates at some point in 2016, I believe US markets will momentarily drop. I base my reasoning on the logic in the above section. Yet even when the whole market drops, there are still great investment opportunities available out there.
Kiysoaki would say there are even more opportunities in a falling market. Whether its real estate, stocks or derivatives, Kiysoaki likes to buy when markets are going down, not up. But in order to make money in a declining market, you need to know what you’re looking for — and it isn’t necessarily blue chip stocks either.
You need to invest in stocks that ‘weather the storm’. Stock that keep rising as the market tanks. I’m not talking about stocks that are oppositely correlated to the market. Instead, I’m talking about stocks that continue to perform when others don’t.
And that’s when you need to focus on the business, rather than the economy. Digging into a company’s financial statements will often tell you many things you might not have known about the company.
If it’s likely that a company will grow profits into the future, the state of the market should have little effect on your decision to buy. Warren Buffett, the world’s most recognisable investor, doesn’t care what the stock market is doing. They could close the whole exchange tomorrow for all he cares. Mr Buffett’s sole concern is the business.
And it should be yours, too. Do your research, analyse as many financial statements as you can, and stick to a plan.
Junior Analyst, Money Morning
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