Oran Hall | The far-reaching effects of a strong stock market

A strong stock market is good – for governments, businesses, individuals and the economy. It shows that companies are making profit and creates opportunities for investors to make money. To believe that it brings endless joy and prosperity, though, is foolhardy.

A strong stock market is good for businesses because it creates opportunities for them to raise capital – equity and debt – thus enabling them to expand. It creates opportunities for people to make money from capital gains primarily, but also dividends from profitable companies.

For the economy, it fosters economic growth as businesses expand and new businesses are born, and it generates wealth for people enabling them to consume more and generate more taxes for governments to do more.

The stock market grows when companies are making money and illustrate that they will make money in the future. After all, the stock market is driven by expectations of future profit, not so much by past and current profit. A strong stock market is a vote of confidence in the economy. It is a statement that people believe that it is strong, that it will continue on a growth trajectory, and that it is on a stable and solid footing.

When the stock market makes people richer by increasing their net worth, they do more than consume more; they save and invest more. They are also able to spend more on important priorities like education. Their actions create a multiplier effect which redounds to the benefit of the economy although they may direct some spending to imported goods and services.

A strong stock market is good for pension funds, particularly defined contribution funds. Strong returns on such funds mean higher pension payments for members. Effective investment policies can put a brake on managers who may be inclined to skew the funds too heavily towards equities when the market is doing well.

In any case, a rising market tends to cause significant changes to the asset mix just by virtue of the increases in the prices of stocks. Proper management requires periodic re-balancing, for stock markets inevitably reverse their upward trajectory.

A strong stock market is good for the owners of life insurance policies linked to segregated funds which invest in ordinary shares.

The increase in the price of equities boosts the value of such funds and is good for policy holders, who may borrow against the values and withdraw funds, where it is allowed. The beneficiaries of such policies also benefit upon the death of the insured person if the death benefit is the sum assured plus the investment value of the policy.

A strong stock market is good for companies that have an investment portfolio that includes stocks. Life insurance companies, for example, have such portfolios. Good-performing investment portfolios can also boost profits.

Other entities like the National Insurance Fund, investment companies, stockbroking companies, and listed companies also have equity positions in companies.

Because the capital gains on equities is not taxed, investors derive good tax-free returns when increases in the price of equities boost their realised capital gains – which is also true for investments in the capital growth funds of unit trusts and mutual funds.

Buying equities when the market is rising is not necessarily the best time to invest in them. It could mean buying when the market is close to or at its peak, so the chances of making good gains could be seriously eroded. Worse, it could mean making a negative return when the direction of the market reverses. It is generally better to invest methodically.

Value is important when investing in the stock market, so it is worthwhile to consider the fundamentals of each company before investing. ‘Following the herd’ can be costly, and buying the stock that did well on the market recently is not necessarily the way to go. It could mean buying at its peak.

What seems to be a bad buy in the current cycle does not have to be a disaster. It could do well in the next cycle, which does not have to be way into the future.

Preparation is important. Good research is one of the best ways to prepare. Learn some of the basic tools to analyse investments and markets. Pay attention to the markets and stay clear of hot tips. If you must get advice, ask relevant questions of the adviser and buy what you determine you should buy, not necessarily what somebody says you should buy.

Even in a strong market, the rules still apply. Diversify – do not put all your eggs into one basket. Build a portfolio with different types of instruments and with different instruments in the same asset class. With respect to equities, invest in several industries and markets, where possible, buy stocks in sound companies, and avoid greed.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com