Is Bad Economic News Good for Your Investments?
Updated: Jul 27, 2022
Are poor economic indicators a good thing for your investments? The argument that they could be is based on the fact that poorer economic conditions would suppress demand for goods and services, and hence result in a pivot of central bank policy to stop raising rates and perhaps even decrease rates. Therefore, based on lower rates the stock market would rise in anticipation of the economic recovery.
The "wealth effect" is also often sighted when talking about the stock market as a forward looking indicator. It argues that as stocks rise investors are more wealthy and spend more increasing economic activity, and conversely when stocks go down investors are less wealthy and spend less decreasing economic activity.
These ideas between central bank policy and the wealth effect driving the stock market prices are not independent. Rather these concepts work with one another. When central banks lower rates to stimulate demand that generates a positive wealth effect and stock markets rise, and conversely when central banks raise rates to reduce demand (usually to reduce inflationary pressures) that generates a negative wealth effect and stock markets to fall. This phenomenon has led to common saying in markets "don't fight the fed (aka federal reserve)" as that is the ultimate driver of equity markets.
But off course equities are just one asset class. Does this also hold true for real estate? I would argue yes as it is essentially the same thing, but there is a key difference due to the fact that stocks are a very liquid asset compared to real estate. Hence, the same wealth effect applies it just takes a little longer period of time. For example, North American markets have been falling most of this year in anticipation of higher interest rates while Real Estate prices and demand have stayed relatively strong throughout the first half of the year, and it is only in the past couple months that we're starting to see the beginning of a slowdown in the housing market.
There is also the phenomenon in real estate that before anticipated rate increases there is a surge or rush of consumers to "get-in and lock-in" lower mortgage rates. I'm not entirely sure that this is the most rational behavior and is perhaps media driven, but I would expect whatever you'd be saving in interest rates you'd likely be losing out on price unless one was able to lock-in rates long enough to take full advantage of a large and sudden price drop.
The main concept to understand here is that markets are cyclical and what goes up must come down and vice versa. It is an inherit part of the central bank driven financial system that we live in, and as investors we must both understand and embrace it.