Below is an excerpt from Chapter 2: The Importance of Economics in Generational Wealth: Business & Investing Guide To Building An Empire.
How well a particular investment performs is generally influenced by the state of the economy. Before learning about a specific investment, it is essential to learn about the economy and the impact it has on the world of investing. Also, it is very important to know what economic cycle you are in and know how to adjust and react to each climate accordingly.
The economy is measured by several economic indicators that take the temperature of the economy, and some indicators even give a future forecast on what is expected of the economy in the future.
Of all the economic indicators, some are more important than others. The most important economic indicator is considered by many as the parent indicator, and that is the gross domestic product (GDP). The GDP is the total dollar value of all goods and services produced by labour and property in the United States.
A GDP that is increasing signifies an economic growth cycle that may cause inflation, and a GDP on the decline signifies an economy that is slowing down and may have the potential to cause deflation. Inflation is the rise of prices for goods and services; deflation is the decrease in prices for goods and services.
The GDP report measures quarterly activity and has a heavy influence on how people invest and spend their money. The report is released three times each quarter, being revised each time to finally come up with a final report for the quarter during the last month of the next quarter. For example, the final revision of the GDP report for the first quarter (January-March) would be released in June and can be found on the Yahoo! Finance page with all the other indicators.
Keeping track of the GDP growth (or decline) numbers should give you a good feel for the state of the economy and also let you know what phase of the business or economic cycle you are currently in. There are generally five phases in the business cycle as outlined below.
1.) Downturn: Starting from the peak in the economy, the downturn starts when the GDP has its first quarter of negative growth and lasts for as long as the GDP report is signifying negative growth. Two consecutive quarters of negative GDP growth is officially considered a recession. During a downturn, investors generally get nervous and begin to dump quality investments for less than market value. At this time, investment bargains are usually easy to come by.
2.) Trough: The trough signifies the end of the downturn or recession. It represents the lowest level in the business cycle. During a trough, because it is the lowest phase in the cycle, reports start to improve and the economy is getting ready to bounce back. In my opinion, this is the best time to invest, especially in real estate and stocks. Due to a lack of consumer confidence at this point in the cycle, investments are usually at their lowest point. Once you’re at the bottom, the only way you can go is up, so I advise you to buy all the quality real estate and stocks as possible.
3.) Recovery: The recovery begins when the GDP growth is positive again. The recovery is over when the GDP level surpasses the previous peak in the previous business cycle, which indicates the start of an expansion.
4.) Expansion: An expansion occurs when the GDP rate is reaching new heights and continues until it reaches a new peak. At this point, investments normally are costing more than they are really worth. During this phase of the cycle, be careful in what you buy because the peak is coming and on its way. If you buy too close to the top, you may have to sell on the way back down, which will possibly result in a loss.
5.) Peak: The peak is the highest point in the business cycle. In my opinion, this is the worst time to start investing because once you’re at the top, the only way you can go is down.
Now that we have a good understanding of the economic cycle, we can now go into depth on the most important economic reports that generally give you a clue in what direction the economy is headed before the GDP report is even released.
Although there are many economic indicators viewed and adhered to by Wall Street, there are only six of them besides the GDP report that I find important, and they are listed below. It is important to understand that most economic indicators are subject to monthly revisions; therefore, be aware that the GDP reading is not the only indicator that is subject to changes once more data is received by the source of the economic report.
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