How does the global economy affect investing?

Explainers

In a super-connected world, it’s inevitable that global events can impact investment portfolios right here in Australia. Let’s take a look at some examples.

24 May 2022

5 min read

Bird's eye view of cars driving on the motorway

Supply chains

A supply chain is the “chain” of businesses and people who turn stuff from raw materials (like iron, copper, etc.) into finished products. Things as “simple” as pencils are made of products from all sorts of mines and factories, all over the world. 

When these supply chains get disrupted (by wars, pandemics, natural disasters, etc.), there can be flow-on effects—businesses may struggle to get the supplies they need to make their products, meaning they may make less money, have to raise prices, or even go out of business. 

For example, microchips are in pretty much every single electronic device—from computers, to video game consoles, to cars. But in 2020 and 2021, the major factories had to shut down or slow down due to COVID-19 lockdowns—even though the demand for computers increased as people shifted to working from home! And to make matters worse, there was even a drought in Taiwan that reduced capacity for the chip factory that supplies 50% of the world’s microchips

Businesses that needed microchips during this time may have made less money, impacting their revenue, and ultimately shareholder returns. 

Supply chain problems can create a nobody-wins situation: companies have to raise prices because they can’t get their hands on the stuff they need to make their products or services. At the same time, they can’t get enough stuff to satisfy customer demand! So they can end up charging more, but making less, because they’re selling less stuff. 

Interest rates

A big part of a central bank’s job is to “smooth out” the ups and downs in the economy. The main tool they use is interest rates. 

Central banks (like the Reserve Bank of Australia, or the Federal Reserve in the US) may set higher targets for the cash rate in the money markets in which banks lend to and borrow money from each other overnight. Changes in the cash rate then flow through to other interest rates in the economy. When the economy starts to heat up and things are starting to become more expensive—like they were in early 2022 they are more likely to set higher target interest rates. This flows through in those retail banks which may raise the rates they pay to people who deposit money, and the rates they charge people who borrow money from them. 

This is like a “handbrake” on the economy. The goal is to bring prices down by giving people less money to spend which reduces demand. If people have to spend more on interest to borrow, and they can get more interest by leaving their money in the bank, then they may be less likely to buy that new laptop, or pair of shoes. If fewer people are lining up to buy things, then prices may come down. 

This also has an effect on investments. For one, if people are putting more of their money in their own pockets (as opposed to spending it), then they may be less likely to buy products and services from companies. Again, those companies may make less money, impacting their revenue and shareholder returns.

It may also mean that some companies have to spend more money on servicing debt, as bank interest rates increase and companies have less profit to give to shareholders through a dividend or to invest in future growth. Other investments such as bonds provide regular income to shareholders at a fixed price. If investors move their money from shares into bonds or other fixed-income products, this can decrease the demand for shares, which can also affect the share price. 

One thing to note is that interest rates don’t necessarily have to change in Australia to affect investments. If US interest rates go up or down, investments may be affected, even if Australian interest rates stay the same. 

War

The human tragedy is the most devastating impact of war. Wars also have an impact on investments as well, and this impact to certain markets varies depending on how big the war is and where.  

Wars can impact supply chains. Take, for example, the current war in Ukraine. Russia is a big oil exporter, and in March 2022, the US announced sanctions meaning they’ll no longer buy oil from Russia. On top of that, companies like Shell, BP, and Exxon exited Russia on their own. 

Take all this together and it means there’s less oil (and oil products like petrol) available to buy. In other words: lower supply. Any company that buys oil, uses it in its products, and sells those products is going to be impacted; airlines, transport companies, and agriculture are all dependent on oil. 

War also creates a lot of uncertainty around how it’s going to end, when it’s going to end, or what the world will look like when it’s over. If a war is large, or affects lots of industries, people may choose to invest less and save more. 

The behaviour of other investors in response to uncertainty can reduce the value of shares—because less demand puts downward pressure on the price. 

Wrapping up

We live in a big world that’s interconnected, and nobody has a crystal ball to tell what will happen and how things will shake out. 

Wars start and end, and supply chains can tighten and then their problems are resolved. Interest rates go up and down. We just don’t know when, and which businesses will be able to weather these storms. 

It’s important to find a strategy that works for you and your investing goals. Some, for instance, may consider how diversified their portfolio is, explore dollar-cost averaging as a potential strategy, and look to the long term—even if it’s a bit harrowing in the short term.


Ok, now for the legal bit

Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.

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