Written by Jackie McCann-Scott, CHS, CFP
North American money maven Gail Vaz-Oxlade has often said, “Saving is easy. Investing is complicated.” Understanding a few market fundamentals can help clear the confusion and is worth the investment of your time.
“The market” defined
The headlines for most of last year reported that “markets were down.” But what did that really mean? At a high level, these reports referred to the total market capitalization of a group of publicly traded companies that together represent a cross-section of the economy. Let’s break this sentence down, shall we?
Market capitalization or market cap is defined as “the value of a company that is traded (bought and sold) on the stock market, calculated by multiplying the total number of shares by the current share price (Investopedia).” At any time, an investor can easily find out the market cap of a publicly traded company through independent investment research firms, such as Morningstar and Globe Advisor. They can also learn whether that company’s market cap is trending up or down, and whether that results from a change in the share price or the number of shares sold. Companies with larger market capitalization (i.e., $10 billion or more) tend to be more established businesses—often household names like Microsoft and General Mills—and are therefore considered less risky. Conversely, mid- and small-market cap companies are seen as having more potential for growth with more potential for volatility as well. These may be relatively immature companies in the midst of rapid growth, expanding product lines, or diversifying revenue streams.
One of the best-known groupings of individual, publicly traded companies in Canada is the S&P/TSX Composite Index. This index includes approximately 250 of Canada’s largest publicly traded companies operating in all segments of the Canadian economy, including financial services, energy, manufacturing, information technology, consumer goods, real estate, and health care. The total market cap of all companies within the index is calculated using a weighting system. Those with larger market cap are assigned a higher weighting in the calculation of the index’s overall market capitalization. When the total market capitalization of the index is up, it is generally thought that the economy is performing well, and we hear “the market is up.”
Bulls and bears
A true bull market occurs when indices like the S&P/TSX Composite Index grow by 20 percent following a prolonged period of decline. By contrast, a bear market is characterized by a lengthy drop in stock prices and can be seen when an index like the S&P/TSX Composite falls by 20 percent or more. As this index measures the performance of companies operating in a wide cross-section of the economy, it signals that market conditions have deteriorated across more than one industry. This can be caused by market events such as a decrease in demand for products and services, an increase in the cost of manufacturing, an increase in the cost of delivering those products and services, or a combination of factors.
What’s inflation got to do with it?
As society emerged from the lockdowns of a global pandemic, the pent-up desire to consume, coupled with historically low borrowing costs, created the ideal conditions for a bull market. Following an initial drop to bear territory at the start of the pandemic, by late summer 2020, we were back running with the bulls across many sectors. While both demand for products and access to cheap credit reached an all-time high in late 2020 and early 2021, it became evident that companies were struggling to meet that demand. Lack of employees, supply shortages caused by geopolitical unrest, and high energy prices meant that company costs were rising and their supplies dropping. Prices across many sectors rose to preserve profitability (and sustainability), and consumers were forced to borrow more to keep consuming.
This is when the Bank of Canada (BoC) stepped in. By increasing the rate at which it lends money to the major banks, the BoC influences the rate at which those banks lend money to you and me. If it costs more to borrow money from the banks, that discourages people from spending and has a slowing effect on the economy overall. This allows companies to catch up with demand and—when their supplies are replenished—encourages them to lower prices to entice their customers back. As prices come down, so does inflation.
While these rate hikes have been swift and merciless (and, some would argue, a little too late to the party), they seem to be working, as inflation has begun to drop from its 8 percent peak last summer. The rising interest rate environment also has led to increases in the rate investors can earn on high-interest saving accounts and GICs as banks attempt to attract more deposits from consumers rather than having to borrow from the BoC. This in turn encourages people to save more. Win, win.
Putting it all together
Understanding how these market forces interact can help you better appreciate the roles you and your money play in that system. This knowledge can sustain you in times of market volatility and help to ground you in times of market growth. As another famous North American woman, Maya Angelou, once said, when we know better, we can do better.
Jackie is a certified financial planner (CFP) and a certified health insurance specialist (CHS), with more than twenty years’ experience in financial services. She has built a fresh and forward-thinking financial planning practice that aims to educate and empower the clients it serves. Jackie recently led an initiative to help improve the financial literacy of the province’s youth and is a regular guest on local radio, where she helps people gain clarity on a wide array of financial topics. She also wrote a financial column for the Telegram, “The Invested Mama Minute,” for three years and is a past contributor to The Advisor.
She can be reached via jackie@lupinplanninggroup.ca or by calling 709-781-3526.
Comments