there's a wealth of global economic data, but as investors, it's difficult to understand how the economy affects our investments. In this video, I describe the effect of growth, recession, interest rates, inflation, and also Global events on stocks, bonds, and gold. This should help you to navigate the investment landscape with a better understanding of the economic fundamentals. This video is sponsored by Incog, an app that helps you take back control of your data privacy. Let's begin by looking at economic growth and how it affects the stock market. Naively, you might expect that if economic growth is strong, it creates strong demand for goods and services that push up profits at companies, which in turn drives up their stock prices. Well, in fact, what we observe is the exact opposite. So if we plot GDP growth per capita for various countries over a long period of time (and this is over A Century of data that you can see here) and we plot that versus return on stocks in that country, we actually observe a negative correlation. In other words, more per capita GDP growth means less growth in the stock market. The author of the

paper Ritter points out that the increased economic growth comes from increased inputs of capital and labor, and that doesn't necessarily benefit the companies in a country. So that was comparing between countries over a long period of time. What if we were to look overtime for a particular country and look at the relationship between GDP growth and the increase in stock prices? Well, here again, the relationship is not what you'd expect because GDP is fundamentally a backward-looking measure, whereas stocks tend to be forward-looking. For example, if you buy at the worst point in a recession, stocks will already be looking through the darkness to the light of future recovery, whereas economic data will still look very poor indeed. But beyond this obvious lag effect, there's another point which is to do with slippage, and this was from a paper by Bernstein and arnut where they point out that if there is strong GDP growth, what tends to happen is that more shares are issued, and that means if you look at the profits per share earnings per share, then that actually

gets diluted overall for an entire market. So, while overall, there's greater riches in the economy, you don't necessarily share in those riches because of this dilution of your ownership. Another point is that GDP is a domestic measure, whereas profits for companies tend to be international, particularly if it's dominated by some exporting large caps. So, that also weakens the link between domestic GDP growth and the profits and share price growth of stocks. Another point is that GDP growth is strongly driven by new companies. This is the kind of entrepreneurial spirit of the country. So, while that does drive GDP growth, you won't necessarily get exposure to it if you buy that country stock index. Remember that will be heavily weighted towards the older, more established, and successful companies in the country. And then finally, there's also the effect of euphoria that you get when GDP growth is strong. For example, people tend to overpay for stocks when that's the case. For example, if you look at the incredible GDP growth in Japan in the '70s and '80s, that led to a huge

bout of euphoria, and it led people to overpay massively for Japanese stocks, and then inevitably there was the bust that followed, and stocks underperformed as a result. So if anything, the way you should be thinking is as someone who's a contrarian. If you do see that there's a recession and that pushes down the valuations of stocks, look at that as a sale, an opportunity. Be forward-looking and expect things to improve. It's difficult to do it at the time because all you'll hear is bad news, but that way you can generate higher returns long term. Now let's turn to the effect of economic growth on bonds and bond yields. Now there's a long-term relationship between the yield on bonds, government bonds this is, and the nominal GDP growth in a country. So that's not adjusted for inflation. So for example, if you look at US 10-year yields going back to 1960, notice how they tend to track roughly what happens to GDP growth, nominal GDP growth in the United States. Now after 2020 when we

switched the economy off and switched it back on again. The level of GDP went deeply negative, then strongly positive. And now, what's happened is that it's fallen back down to a sane level of growth. But notice what's happened to 10-year yields. They're rising up to meet falling GDP. So, the situation we find ourselves in now, and in the scatter plot, the Red Dot is where we are as I make this video. You can see that the two are roughly in line with each other. Nominal GDP growth would suggest a yield for 10-year bonds of around 4.3 to 5.5%. And the actual yield is 4.6%. Implicitly, what this relationship means is that bonds feed on bad economic news. So, if growth is expected to be low, that pushes down yields and it pushes up bond prices. But the key point here is that what drives bonds and stocks are different economic factors. They tend to respond in different ways to good and bad economic news. And this is why stocks and bonds tend to diversify one another.

quite well most of the time, although we will see an exception in a moment. Today's video is sponsored by incog. Now, you may not be aware, but third parties can actually buy your data, and they're allowed to do that. It is legal, and that data would include things like your name, your date of birth, your address, any email addresses you've got, phone numbers, even your relatives, and of course financial information. Now, the people who actually trade that data legally are called Data Brokers. So let's say you apply for some kind of financial product, the company you're applying to could buy data about you from one of these data brokers, and that's a legal use of the data. What you also find is that scammers buy this data too. So personally, I'd much rather that nobody could buy it at all. Now what you could do is research all of this yourself, find the names of the data broker companies, contact them, and ask them to remove your data. However, this would take a lot of time. So what incog does is contact all of these data

Brokers for you. I first opened an account with them in January 2024, and you can see that they've added me to 19 suppression lists. I can also see the detailed view of what they've done, and I can rank these data brokers by severity. So these three companies are ranked as high severity. So if we drill into one of them, you can see precisely what the risks are: identity theft, spam email and calls, data leaks, and so on. And you can see that in this case, the broker's being suppressed, so they can't use my data. Now, viewers of PensionCraft get a special discount from Incog, such that you get 6% off your annual plan. To claim that discount, you can use our promo code, which is PENSION. Alternatively, click on the link in the description below. How about a period of negative economic growth or a recession? Well, the difficulty here is that very few of us can see these recessions coming. Some people claim to be able to, but it's usually not true. So what can we do to prepare for that? Well, one way to

prepare for it is to be diversified. If you have assets in your portfolio like stocks, bonds, but also gold that respond in different ways to economic news, then even if there's a recession, at least some of them will be performing well. So, if we have a 100% stock portfolio and we look at every 10-year return since 1970, notice that there were periods where an entire decade was lost. These are decades that started in the 1970s and in the early 2000s. So, a 100% stock portfolio in a given country tree will be subject to these periods of underperformance. How about if we diversify across different types of stocks but also different asset types? One portfolio which does fairly well through good times and bad is called The Golden Butterfly, created by Tyler, who created the Portfolio Charts website, which is where this data is from. This portfolio is called The Golden Butterfly because if you plot the pie chart of its allocation, it looks a little bit like a butterfly. But notice how it's very, very

simple. It simply allocates a fifth of your portfolio to five different things: the total stock market, small-cap stocks, long-term bonds, short-term bonds, and gold. And now what we see is that the returns tend to be less volatile for these 10-year periods. There is no 10-year period when the return was deeply negative. So while the highs aren't as high as they would be for 100% stocks, you also don't get those really awful decades which would put you off investing altogether. Now let's turn to inflation and see how it affects stocks, bonds, and gold. If we look at the period since 1871 in the United States and plot the returns of stocks (the S&P 500), but also 10-year treasuries and gold, and have also shown inflation over this period, all three of those investments beat inflation. And if we look at the increasing rates of return, gold has the lowest return, then we get US 10-year bonds, and then we get stocks with respective returns of 3.2% per year for

gold 4.6% per year for treasuries, and a very respectable 9.1% per year for stocks. So certainly, if you want to beat inflation long-term, stocks have been the way to do it historically. However, it's unlikely that we're going to live long enough to see these long-term trends in some cases. So, this is why it's not a bad idea to have some diversification because it's not always the case that stocks can beat inflation. If we plot the valuation of stocks, this is using Robert Schiller's Cape measure versus the rate of inflation on the x-axis, we get this kind of peaked shape where the highest valuations are for a rate of inflation of around 2% to 3%. But notice what happens if inflation really increases a lot. What we get is during the valuation multiple of stocks falls as people lose confidence in stocks to a certain extent. Stocks can weather inflation because what companies can do is simply raise their prices to match price increases, but at a certain point

customers will not be willing to pay ever higher prices, and this means that profits fall, and margins fall, and stocks derate. So, a small amount of inflation can be easily absorbed by stocks, but once it gets too high. Beyond about 5%, then it becomes a problem. Similarly, in deflation, when prices are falling year over year, that usually is a symptom of a sick economy with very little demand for goods and services. And again, what happens here is that stocks derate. So, here what we'd expect to do well in a period of deflation would be government bonds. Now, what we saw recently in 2022 was that inflation surged, and at the same time, stocks and bonds fell simultaneously. In other words, this hedging relationship where bonds tend to cushion losses in stocks broke down completely as both fell together. And historically, we've been here before. We saw it in the 1970s. You can see in this data here from Schroers that when inflation is high, the correlation between stocks and bonds increases. And that's because, as we saw

High inflation is toxic for stocks. They derate, and because with bonds you're locky in a fixed rate of interest, a high inflation rate is like Kryptonite for bonds as well. So in a period of really high inflation, gold here may be useful in your portfolio. Another asset which holds up surprisingly well would be things like money market funds, which although they're quite boring, don't necessarily lose a lot of value. That's because they're not lock you in a fixed rate of interest for a long period of time. They've got very short duration. So here again, depending on the inflation regime that we find ourselves in, and remember it's not predictable, then diversification helps us because different assets respond to inflation in different ways. Now let's turn to the effect of interest rates on those three assets: stocks, bonds, and gold. Starting off with stocks, the effect of higher interest rates depends on the sector that the stock is in. Different Industries will be differently impacted by higher rates of Interest. Financials, which make some of their profits from

lending actually may benefit from higher interest rates, whereas other sectors that require borrowing in order to boost their returns, and the classic example is real estate, would be negatively impacted by higher interest rates and a higher cost of funding. Utilities companies also tend to be heavily reliant on low cost of funding to fund their infrastructure, and growth stocks also rely on cheap funding to grow their revenue, so all three of those sectors would be negatively impacted. In contrast, sectors like Health Care, communication services, and consumer staples are much less heavily dependent on funding and would probably hold up much better if interest rates do increase. If we turn to bonds, the effect here is slightly more subtle because what you'd expect to happen is if interest rates increase, then by definition yields will be increasing and prices would fall. That effect would be immediate, so if you've got a bond in your portfolio already or a bond fund, the price of that fund would fall straight away, and the longer the duration of your fund or your bond, the more the price would fall. But then what

happens is more nuanced and takes longer, but because newly issued bonds will have a higher rate of interest baked in, that increases your income as yields rise. So, the initial shock is bad, it pushes the price of your fund down, but the longer-term effect is a positive one, which is that newly issued bonds enter your portfolio and push up your income. You can see that in the case of this fund, which is issued by Vanguard. It's VOV. It's a guilt fund. It buys UK government bonds. Notice how in 2022 its price tanked as yields shot up, but then what we see slowly over time is, if you look at the dividend payments, which are monthly for this fund, they gradually increased over time as new bonds were bought by the fund with higher coupons. In the case of gold, it generally has a negative relationship with interest rates because it doesn't generate an income itself. And if you can buy treasuries which do generate an income, a higher income when rates increase, then it'll become less attractive as an

investment, particularly as it's quite volatile, whereas bonds tend not to be if they're fairly short duration. In PensionCraft, we've got a fair value model for gold, which we give to our members, and this is available on our website. But this has three drivers; one of them is the level of inflation because, as we saw, gold does tend to track inflation long term. But the other factors would be the value of the dollar, the trade-weighted dollar, because the price of gold is measured in dollars, and a weak dollar pushes up the price of gold. And the model also includes real yield, so when yields are high, that tends to push down the price of gold. So here is that model right now, and you can see that the price of gold is overvalued by about 14% as I make the video. And if you want to have access to this and other tools that come with our premium website membership, just go to our website pensioncraft.com. Finally, let's consider global economic events. Now, some events create fear, and this would be

some kind of crisis. It could be a war, and these are fundamentally unpredictable, and these affect markets because when people are scared, they tend to sell their stocks and buy safe things, which in this case would be things like US Treasuries, UK gilts, and other developed market government bonds. But also, people tend to flee to things like money market funds and gold. If there is a severe economic event, such as a pandemic, then it affects things like demand for goods and services, but also things like international trade. Now, the biggest players in international trade are primarily three countries. No surprises that China's top of the list, but the US and Germany are also considerably higher than the rest of the world when it comes to the value of their exports. So, Chinese exports in 2022 were about $4 trillion, the US was about $3 trillion, and Germany was about 2 trillion. Then the next highest falls all the way down to 1 trillion, and that's the UK, which exports a lot of services. But it's when this trade breaks down.

that you get real problems, and what we've seen recently is a lot more talk of protectionism, where a country puts tariffs onto its imports in order to protect its domestic producers. Now, if we look back in time, tariffs were much more common in the past than they are now, both in terms of size but also the number of countries which imposed them. Here you can see data for France, the UK, and the US, and all three of them had very high tariffs for a very long period of time. Notice how following the Great Depression, tariffs fell out of favor. Many people pointed the finger at tariffs for worsening that huge economic depression, which was global in scale. Then we had organizations like the World Trade Organization, which was designed to allow free trade and to create a kind of level playing field, but the narrative has changed noticeably recently because there's a growing feeling in developed countries that China is abusing its role as an exporter by subsidizing its companies and subsequently undercutting prices in developed markets, particularly for high-value added and technological industries, for things like electric cars.

but also electronics. This is why first, the Trump Administration, now the Biden Administration, have hugely increased tariffs on imports from China. In May of 2024, for example, tariffs on things like electric vehicles from China were increased to 100% by Biden. Now, there are hardly any Electric Car Imports to the US anyway, so this is more of a preventative measure to allow the US Electric Vehicle industry to really get off the ground. This is because China has pretty much beaten them to that game, but also other key Industries things like semiconductors, but also solar cells, have also had these tariffs imposed. Now, the problem is that if you go back in time to the 1930s, say if you look at something called the Smoot-Hawley tariff, initially it actually made things look better. It had the desired effect, which was to slow down imports and favor domestic producers of things like agricultural goods. However, what followed was retaliation from other countries, and those were very severe, such that the US's exports also were cut, so the

consequence was that a world that was already scarred by the Great Depression fell into an ever greater slump. Hopefully that won't happen this time because these tariffs are very surgical. They're very focused in certain sectors, but who knows if it does escalate, then I suspect the impact will be negative. But if we go back to that beg of Thy Neighbor type of tit for tat response, then we could all be poorer as a result. Another problem is geopolitical instability because if trade does break down, countries which trade together tend not to go to war against each other. So if there is a breakdown of trade, I think there's a greater risk of geopolitical instability. And as we saw with Russia's invasion of Ukraine, what happened as a consequence of that breakdown of trade, and that's because countries imposed sanctions against Russia, was that energy prices surged. A lot of countries such as Germany, Hungary, Poland, the Czech Republic were heavily dependent on Russia for their supply of natural gas. So geopolitical instability, particularly from commodity producers, can be a huge problem for the global economy.

unfortunately, it is unpredictable, but here again diversification can help you to some extent. For example, if you don't have a 100% stock portfolio and there is fear due to a global trade war, then at least some aspects of your portfolio will do well. And of course, there's a possibility of an all-out war. For example, there's a lot of worries at the moment about what's going to happen in the South China Sea and whether China may invade Taiwan. If that happens, then this could escalate into a global conflict. So again, having some safe haven assets in your portfolio like gold, like cash, like short-term government bonds will protect you if that happens. So I hope this video has helped you understand how economic factors can drive the returns in your portfolio, but also why it's important to be diversified because if you are, then at least some aspects of your portfolio will be able to weather whatever the economy throws at them. Now, don't forget our offer from Incog. You can take back control of your data and get 60% off an

annual plan. Just go to the link in the description below or use our promo code, which is pension. And as always, thank you for listening.

Understanding The Impact Of The Economy On Your Investments

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

Before starting PensionCraft, I worked in investment banking as a strategist and I was a frequent contributor on CNBC and Bloomberg TV. I have written two books about finance and investment: one for professional investors and one that explains how to buy and sell volatility using exchange-traded products.

I publish a new video on YouTube every Saturday and you can join me for a live Q&A on the 1st Thursday of every month at 7pm UK time.

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