Economic trends do affect your investments

Do you often stop paying attention to the TV news because once again commentators are going on about inflation, securities prices, and interest rates?

All this talk about the economy can be confusing, and it's tempting to just tune it out.

However, as an investor, you might benefit from some basic information about economic trends and how they affect your investments.

The business cycle

The economy goes through stages of prosperity that are often referred to as the business cycle.

While "cycle" implies a regularly repeated pattern, the economy is anything but predictable.

Usually, there is an initial period of rapid economic growth, followed by a period of slow growth or even stagnation.

The length of the economy's expansions and contractions has varied over the years.

Stocks and the economy

The economy and the stock market are closely connected. During periods of economic prosperity, consumer demand for goods and services leads to increased sales and higher profits for businesses. Stock prices as a whole tend to rise.

Periods of recession have the opposite effect. Sales become sluggish or decline, and earnings diminish. During periods of economic downturn, stock prices tend to fall.

Cyclical industries, such as automobile manufacturing and home construction, tend to move with the economy.

Car sales and housing starts can vary significantly from year to year because consumers can defer purchases of high-price items like these from one year to the next.

Consumer-staple stocks, such as food companies, tend to be more stable even when the economy is in a recession. While a family might do without certain luxury items during a recession, they can't go without buying groceries. Stocks in growth industries tend to do well during periods of economic expansion.

Bonds and interest rates

The Federal Reserve is the central bank of the United States. When the Fed believes that the economy is expanding too quickly, it may raise short-term interest rates to keep inflation under control.

Inflation is an overall increase in prices of all goods and services resulting in the decline in the purchasing power of the dollar.

If the economy is in a slump, the Fed may reduce short-term interest rates to make borrowing more affordable and stimulate business and consumer spending.

Higher interest rates are usually bad news for bonds, especially long-term bonds.

As market interest rates rise, existing bonds pay a lower interest rate than newly issued bonds. As a result, the market price of existing bonds goes down.

However, bond prices usually rise as interest rates fall.

Your investment strategy

While it's helpful to understand the effect of economic trends on your investments, it is not a good idea to alter your investment strategy based solely on changes in the economy. As a long-term investor, any changes to your portfolio should be based on your risk tolerance, your personal goals, and the amount of time you have before you retire or need to withdraw the money in your investment account.

The old adage that the time in the market is what counts, not the timing of the market, is certainly true in these times of market volatility.

No one can predict with certainty whether the market has reached the bottom or top.

The most successful investors are those who stick to a regular investing strategy in good markets and bad markets.

(David Compere is a vice president and trust officer with Springfleld Trust Company.)