Investment is a subject/matter which involves risks. Before investing, an investor must understand the level of risks and returns involved in the market. Time plays a vital role in the management of risks and returns involved. The higher the level of risk, the higher the return and vice versa. Besides risks and returns, there are several external factors that affect investment growth such as:- business cycle, political instability, fiscal policy, monetary policy, government policy, etc and so on. External factors cannot be controlled but can be managed from the policy level. This essay clearly explains the concept of investor resilience in changing economic conditions focusing on how investors need to manage portfolios, minimize risks, grab opportunities and overcome challenges:-
A. Economic Conditions and Portfolio Management
i. Economic Cycles:-
Economic cycle refers to economy-wide fluctuations in production or economic activity over several months or years. The phase of the economic cycle:-
Fig: Phase of Economic Cycle
During the peak phase, Growth opportunity slows down and attains its maximum level. During the recession phase, Production, prices, savings and investment starts declining. The depression phase is the phase in which the economic activities of a country decline below the normal level. In the recovery phase, economic factors such as:- investment, employment, and production start rising. Usually, the depression phase seems to be the best phase for smart investors to invest in. Investors need to be motivated especially during the depression phase, either from the policy level or any other means.
ii) Assets Allocation:-
One of the best strategies for managing a portfolio in changing economic conditions is asset allocation. Diversifying one's portfolio as an investment helps us to mitigate risks. “ Don’t put all your eggs in our basket” is a popular saying. It means we need to diversify our funds as:- stocks, bonds, real estate, fixed deposits, etc.
iii) Risk Management:-
The level of risk varies from one investor to the other investor. For some investing in a bull period might be too risky while some only invest during the bull period as the returns seem to be quick. Investors can minimize the risks involved using various techniques such as:- diversified portfolio, stop loss, etc.
B. Decision-making in a shifting Economic Environment
i) Informational Gathering:-
In the era of the 21st century, investors have full access to all the information's. It includes company reports, financial news, country economic news and research analysts' and experts' views.
On analyzing and going through the information they need to shift their investment funds as per the changing economic times. Investors can take suggestions from Research Analysts who are continuously analyzing and working in the market for a long time.
ii) Long-term Perspective:-
People want everything quickly. People these days don’t value the power of compounding. Warren Buffet says,” sit back and let compound interest work its magic”. Resilient investors adopt a long-frame perspective, we need to understand that markets take time to recover. In short, Empires are not built in a single day. So, investors need to invest and sit back and let the power of compounding do its work. A long-term investor should follow the 3i principle in investment that is:- information, interaction and then investment. Patience is key as markets take time to rebound.
iii) Emotional intelligence:-
Emotional Intelligence is the ability to manage both your own emotions and understand the emotions of people around you. An investor should understand the emotions of the masses but should not follow the masses. An investor should not fall into the mass emotional trap and therefore should take one's own decision and should avoid irrational and quick moves. In the present context, the forces of supply and demand result from two powerful emotions: demand results from the hope for profits, and supply results from the fear of loss. When these two opposing forces are not in balance as of now, stock prices move down as the supply side is greater and vice versa.
C. Strategies for Different Economic Conditions
i) Bull and Bear Market:-
A discerning eye can distinguish between bull and bear markets. When the trend line creates higher highs or higher lows then the market is bullish. In a bullish market, there is high buying pressure resulting in high demand. In such market trends, people usually do a lot of trading rather than investing and are willing to take higher risks. Small investors get trapped whereas big/smart investors/players earn a lot and withdraw themselves from the market at the right time. Similarly, when the trend line creates lower lows or lower highs then the market is bearish. In a bearish market, there is strong selling pressure resulting in high supply. During this period, long-term investors get a long time to accumulate the stocks at low prices. This period is best for investment purposes if one can do proper research at this time and pick the best growth stocks. Investors turn to dividend-paying companies, and safe-haven assets like gold and government bonds and are willing to take less risks. The focus shifts to capital preservation rather than taking trades. As we know, our Country's market NEPSE is a way market. Here, bull and bear markets are decided by interest rates, liquidity and some policies set by the policymaker. I have explained the game of interest rates and liquidity in NEPSE hereby;
Fig:- NEPSE from 1993 to 2023
Nepal Stock Exchange (NEPSE) formally opened its trading floor in January 1994. Initially, NEPSE had only 37 listed companies. Over the past 29 years, the market has grown significantly, with more than 250 tradable listed companies. Despite this, in a short frame of time, NEPSE has experienced 4 booms and 4 crashes. This essay clearly dictates the changes from bull to bear and bear to bull with the changes in interest rates followed by liquidity.
NEPSE increased by 389 points from 1999 to 2000 in a short span of time. During the year 1999, the banks' interest rate was approximately 9%. Along with the increment in NEPSE, banks' interest rates started to fall encouraging investors to invest in the stock market. By the end of 2000, the bank's interest rate fell to 8.25% when NEPSE touched its all-time high. Slowly, banks started their margin call and NEPSE declined to 200 points representing a loss of more than 60%. At the time when the market was falling, investors experienced a liquidity crunch in the market followed by increased bank interest rates. Similarly, NEPSE surpassed the previous high and reached 1175 points in July 2008. During the period, the bank's interest rates were 9%. The 2008 financial crisis tested the investor's resilience worldwide. Those who had diversified portfolios were not as much panicked as compared to others. The inverse relationship between interest rates and the share market once again took over the investor's confidence. As the bank's interest rates reached 13%, NEPSE hit its bottom in the year 2012 NEPSE reached 300 points as the massive fall took over. The global financial crisis of 2008, resulted in a brutal fall of the market by more than 76% over a span of 4 years and more.
In the year 2016 NEPSE again surpassed the previous high and created a new history reaching 1881 points. This time this rally was a fantastic rally as the NEPSE index had gained more than 550%. This was due to a lower interest rate of 9.5% and some favourable policies of Nepal Rastra Bank expanding commercial banks. In the year 2015, Nepal experienced a severe earthquake which directly hit the real estate sector and indirectly the capital market too. Slowly bank's interest rate rose and reached 11% which again led us to a bear market and the NEPSE index reached 1200 points in 2020. A massive fall of over 681 points in the market which led to drove the investor's confidence down. In the year 2020, an online TMS system was launched in NEPSE. During this year, people couldn't go out of their houses due to the COVID lockdown. So, Due to the online system, this was the only way for investors to gain confidence in the market and NEPSE again reached its all-time high of 3200 points within 21 months August 19, 2021. At the time NEPSE reached an all-time high, the bank's interest rate experienced a time low that is 6.66%. similarly, with the rise in bank interest rates, liquidity crunch, unfavourable monetary policies, and rise in risk weightage ratio, caps on share loans turned the downtrend of the market. It was being followed by the Russian-Ukraine conflict and the global financial crisis impacted the downtrend. The January 2023 World Economic Outlook Update projects that global growth will fall to 2.9 per cent in 2023 but rise to 3.1 per cent in 2024. The 2023 forecast is 0.2 percentage points higher than predicted in the October 2022 World Economic Outlook but below the historical average of 3.8 per cent.
In short, there is an inverse relationship between interest rates and the share market as seen in the history of NEPSE and it is more clearly shown in the figure chart above. Now, it is the best accumulation phase for smart investors as NEPSE always surpassed its previous all-time high as banks' interest rates fell. In the present context, the removal of unfavourable policies, removal of share loan caps and other unnecessary policies can drive the market uptrend. I hereby believe that once again NEPSE will gain shareholder's confidence soon and surpass the previous all-time high resulting in high growth in the index in a short span of time.
Renowned investor Warren Buffet Says that ''a bear market can be seen as an opportunity to acquire valuable companies' stock when their stock is on sale''. Warren Buffet remains steadfast in his investment principles, focusing on the intrinsic value of companies rather than short-term market fluctuations. With long-term perspective and emotional discipline, one can have yielded consistent returns over decades.
ii) Inflation and Deflation:-
Inflation is defined as the rate of increase in prices over a given period of time. when inflation is increasing, banks will increase interest rates to encourage people to spend less and save more. Inflation is controlled by central banks by adopting certain changes in monetary policies. With the rise in interest rates, the purchasing power of people declines which ultimately reduces the demand side resulting in high supply, which is seen in the present context.
Deflation is defined as the rate of decrease in prices over a period of time. Deflation will result in lower interest rates as the demand for money drops. The stock market slugs down, unemployment rises up, and home prices drop precipitously. During this period, investors favour cash, companies with strong balance sheets and stocks with high dividend-paying capacity.
In short, investor resilience in changing economic conditions is a multifaceted and universal concept. An investor should maintain a long-term perspective and should diversify their portfolio in order to mitigate risks and overcome any other changes in the policy/regulatory level. Investors should be given training programs by investment companies, brokers, merchant bankers, etc so that they don't panic as the bear starts and they can take the real benefit of the bear in the future. Investors must remember that the path to financial resilience is paved with knowledge, patience, and commitment. Bull and Bear markets can be seen as the same as the economic cycle as after every rise in the market there is a fall and vice-versa. In the present context, Smart investors should use this bear time properly and try to hold the stocks till the bull resumes. The stock market reflects the mirror of the overall economy. The stock market prices are likely to reflect the same sentiment if the GDP is increasing and the economy appears to be improving, though not always in the short term. Instead of demotivating people, the government and the policymakers should always encourage the public to invest as the government also generates tax from this sector. Also, the government should slowly bring international laws in this sector so that FDI (Foreign Direct Investment) is encouraged. For instance:- At the present time, companies distribute their dividends annually but in order to attract FDI they should set the rules as the companies should distribute their profits to their shareholders quarterly in the same way as they publish their quarter reports. The world of investment is not for the faint of heart, but for those who navigate its challenges with skill and foresight, the rewards can be bountiful.
Article By: Suraj Agrawal
Birtamod -4 , jhapa