Dear DiscussEconomics, Here I am on the freeway again, the highway that cuts through our city. You say I shouldn’t complain because in the east gas went from $1.03 to $1.34 in a matter of hours. But I can still see the dollar bills flying out the tailpipe. Now that wouldn’t be so bad if they actually fell on to ground where some needy person could pick them up. But the money is evaporating into thin air or should I say ending straight up in the oil companies’ coffers….

Sure my RRSP mutual funds have oil stocks but what a roundabout way to make money. Shouldn’t I be thinking of conserving gas and using that money to invest myself? We all know the answer to that question is YES! But caution: As one successful fund manager said: “If you do what everyone else is doing in investing you will get hurt”…..

Now isn’t that a twist from the usual. We usually think of how the economy affects our wallets not vice versa. This issue will be a newsletter in the literal sense, as recent events must have people reflecting on where and what the economy is doing.

Consumers and investors have a great impact on, for example, the stock market, though they are usually unaware of their influence. Stop and think for a minute about the different money types.

The hoarder stuffs his money in the mattress. In so doing he reduces the flow and amount of money in the economy. Thank goodness there aren’t too many of them.

The saver puts his money in the bank. This in turn allows the bank to invest, lend money, and therefore profit. The people who borrow from the bank can participate in the economy as well. Thus the saver allows institutions to increase their bottom line, and also allows others to spend.

Spenders also stimulate the economy. Spenders’ habits contribute to the cycle of supply and demand. Let’s illustrate with an example:

Summers mean more travel by car or plane. This increases the demand for fuel. An increase in consumption usually affects the supply of a commodity. Both increased demand and decreased supply cause the commodity to become more expensive. Now imagine for a moment if enough Canadians decided to tell the gas station to stick their product where the sun doesn’t shine by:

• Taking a local holiday.
• Trading in their present vehicle for a motorcycle or scooter.
• Deciding to telecommute to work.

Demand for gasoline would decrease. Supply would increase and prices would fall.

Investors also affect the economy and stock market. Interesting enough, investors’ PERCEPTIONS cause them to take certain actions which also influence the market. In the futures part of the stock market professional investors try to forecast demand and prices at a given point in time.

Let’s return to the commodities sector, specifically oil and gas. The perception is that oil and gas stocks are the place to be, just like technology was a few years back. This perception of energy companies cause people to invest in this sector. This causes others to want to participate too, which is in part why prices go so high.

The stock market is also influenced by world events. Two examples that cause the price of oil(and in turn fuel)to rapidly increase are political unrest in the Middle East and Hurricanes (among others). Investor and consumer confidence have huge influence on market prices.

Hurricane Katrina was another matter. The weather catastrophe caused an actual decrease in oil production, which drove up the price of gasoline. And to aggravate matters demand did not become less.

These short term fluctuations are called noise, and stock prices of companies in the market are affected by “noise”. But in the long run (which is what serious investors are interested in) the market will reward those companies that are have great management, little debt, consistent cash flow, and the discipline to adhere to their business plan.
Professional money managers handle noise in one of two ways: they ignore noise, which is value investing, or try and take advantage of it, which is momentum investing.

Do politics affect the economy? The short answer is of course. World governments are more conscious of how their action or inaction affects the economy and tend to be more proactive than in the past.

Here are examples of political events that could affect sectors of the economy.

• Government regulation of stem cell research.
• The process of government approval to bring new drugs on the market.
• Approval or not of bank mergers.

One government action that everyone should be interested in is how they set the prime lending rate. The prime rate determines what interest rate borrowers will pay for mortgages, car loans and lines of credit. The prime rate was raised recently and is forecast to continue rising. The Bank of Canada is increasing interest rates in part to influence Canadians’ borrowing behavior. There is a concern that an economy running on a lot of debt is unsustainable.

This should concern anyone that has debt. Are you prepared to have a higher monthly payment? If for whatever reason you could not work for a while have you prepared your safety net? 40% of Canadians have no emergency fund, and hopefully none of my clients are in that category. A credit card or line of credit IS NOT an emergency fund.

Another noteworthy event that occurred recently is the elimination of the foreign content rule for RRSPs. Planholders may now have any amount of foreign funds in their portfolio.

There are advantages to increasing the foreign content in a portfolio. One of the advantages is due to the fact that 70% of the Canadian stock market is made up of two sectors: commodities and financials. Increasing foreign content allows the portfolio to be more diversified which usually offsets volatility. Also markets outside of Canada usually have better returns over the long run. Anyone who has an RRSP will need to adjust their portfolio. And that ends just a brief wrap of debt, the economy, and market price influence!