If you intend to purchase shares of a company, it pays off to look not only at the company itself but also the environment it is operating in, including the sector, the currency, and the country.
Some of the most common factors to analyze a country’s economy are the country’s national output (GDP), unemployment rate, debt rate, interest rate, inflation rate, surplus or deficit, monetary policy & fiscal policy (increase & decrease of the money supply), and economic freedom.
Why should you analyze a countries economy?
Think about how it would be to buy a house situated next to an active volcano. The house might be well built, the interiors are of good quality, you might have made the perfect deal, but your home is gone if the volcano erupts.
When I started investing in stocks, I was following a guy on YouTube that promoted value investing. He analyzed a company with the ticker symbol CEPU (Central Puerto), an Argentina energy producer. I followed his analysis, did a study on the balance sheet, and all was sound. So I’ve decided to invest in the company without checking the country’s fundamentals, which was a mistake as it turned out.
Argentina has defaulted two times on its debts and is in a long term recession. After I’ve invested, they had elections, a showdown between a capitalist and socialist party, and the socialist party won. Due to this, the stock plunged and didn’t recover since.
I learned the not-so-pleasant way that it is crucial to analyze the company’s environment as an investor, including the sector, the currency, and the country or countries for multinational companies.
The fundamentals of a company can be fantastic. But, when a country falls into a recession, or there are political changes, a country can pull the stock price of all its companies and its currency into the abyss.
From a value investing approach, some might view it as a good investment, as the company’s fundamentals are good, and value investing is a long term game. But then again, looking at it from a margin of safety perspective, the safety wasn’t necessarily there, and a seasoned value investor would have seen this and waited until after the elections.
But this is not a debate about how to look at the investment or if it was a good or a bad one. The crucial part is to know that a country’s economy will influence a companies stock price and potentially its growth. Therefore, it needs to be part of the investment analyses and decision process.
How can you analyze a countries economy?
How high is the country’s national output?
The countries national output is measured in GDP (Gross Domestic Product). The GDP is a measurement that takes into account all that is produced in a country. It is a measurement that shows the total production output.
If the GDP is declining, this might indicate that the country’s economy is weakening, leading to fewer jobs, unemployment, and less output. In contrast, an increasing GDP means that the country’s economy is striving, and more companies and jobs are being created.
Investors like to invest in countries that show growth, rather than in countries whose economy is weakening, as this might lead to less profit. The GDP per capita can be used to compare the GDP against other countries, as it takes the number of residents in the country, and the standard of living into account.
They look at the GDP per capita. If compared against other countries, as it divides the GDP by the number of residents in the country and takes the standard of living into account.
How high is the unemployment rate of the country?
The unemployment rate shows if unemployment is rising or falling. If the unemployment rate is rising, then the country doesn’t do so well. If the unemployment rate is falling, there are more jobs, and the country does well.
The unemployment rate is usually lagging behind the GDP. When the GDP declines, after some time, the unemployment rate will rise. When the GDP increases, usually later, the unemployment rate will fall.
If the unemployment rate is rising, Investors might still search for sectors that aren’t affected, to invest in. Not all sectors might be affected by the slump. For example, during the current 2020 pandemic, technology stocks continued doing very well because the consumption of internet services increased.
How high is the debt rate of the country?
The dept rate shows investors how likely it is that the country might default. If a country defaults, usually a devaluation of its currency will follow, and it can’t repay its obligations for issued Bonds. Many investors will sell their stocks of companies that operate in the country, which lets them plummet. Also, the residents’ living standards might be affected, as there are negative consequences on the job market and buying power.
How high is the interest rate?
Investors who invest in Bonds tend to invest in countries with a higher interest rate and are less inclined to invest in countries with a lower interest rate due to the smaller yield.
If a country decides to decrease the interest rate, you will get less yield on your investment if you invest in Bonds in the country.
If a country decides to increase the interest rate, the yield will be higher, and investing in Bonds is more lucrative.
If, on the other hand, you want to borrow money, then a lower interest rate is great because you can borrow the money at less cost. During a period with low-interest rates, it can be lucrative to borrow money if the investment you put the borrowed money in will produce a higher yield.
For example, if you can borrow money on low interest to purchase a property, which you rent out at a higher yield than the interest rate you pay for the loan, it can be an excellent investment.
How high is the inflation/deflation rate?
Inflation is when the price of goods and services increases over time. Residents of the country need to spend more on goods and services. As long the inflation is slow and controlled, it can lead to prosperity, as long salaries go up. But if the gap between wages and prices for goods and services gets too large, it can cause issues.
On the other hand, deflation is when the price of goods and services decreases over time. On the positive side, people with lower income can afford goods and services that they might not have been able to purchase before. If the gap gets too high and the income of businesses decreases, it will, however, lead to fewer jobs over time.
Are surplus and deficit in balance?
Investors might also want to have an eye on trade surpluses and the deficit of a country. If a country imports more goods than it exports, this is called a trade deficit. If a country exports more than it imports, the country has a trade surplus.
If a country relies on its trade surplus to fund the production of goods and services, and there is a change to the downside, it could impact several economic factors within the country.
Inconsistencies must be monitored and balanced out by the government.
You should especially monitor countries that heavily rely on exports. Especially emerging countries, as changes might affect the GDP and other economic indicators.
Is the monetary policy about to change?
The monetary policy regulates the money supply in a country. The central bank or a similar regulatory body is usually defining the monetary policy. It can either be expansionary or contractionary.
What can the central bank do to stimulate an economy (expansionary policy)?
- Lower interest rates: Lowering interest rates will increase lending. Less interest has to be paid on the money borrowed, and saving money is less attractive because of the lower interest.
- Increase the money supply: This leads to more investments and higher consumer spending, stimulating the markets.
What can a central bank do to slow down its economy (contractionary policy)?
- Raise interest rates: If there is an increased money supply, it can lead to inflation, which means that the prices of goods and services increase. If this happens, it will become more expensive to purchase goods or services for businesses and individuals. By raising the interest rates, saving is encouraged, and because fewer goods and services are purchased, the prices of goods and services will go down.
- Decrease the money supply: Decreasing the money supply leads to less investment and lower consumer spending and is mainly used to keep inflation in check. The negative effect is that the unemployment rates will rise, and companies will expand at a slower pace.
Is the fiscal policy about to change?
The fiscal policy can also regulate the money supply. The government can decide to spend more or less money, which will flow into the economy. The government usually spends money on infrastructure projects, providing educational and unemployment benefits.
The government can also decide to increase or decrease the tax rates for individuals and businesses. If the taxes are high, less money can be invested or spent on consumption, while if taxes are low, it will lead to more investment and more consumption.
Is the country politically stable?
The citizens of a politically stable country can focus on their businesses and work, which will lead to more prosperity than a politically unstable country, which has more turmoil and the citizens might have divided opinions.
It is crucial to view elections and what goals the representatives are pursuing if they get elected.
If there is less economic freedom and the country is interfering in markets, then this might lead to issues for investors.
Source of Data
One good source for economic data of countries is Trading Economics.