The challenge in managing investment risk deals with two basic issues. The first one is to select the asset that investors think offers the greatest opportunities. History shows that stocks are the asset of choice in declining and/or low inflationary periods. Hard assets, such as real estate and commodities, have proven to provide superior returns during times of rising and/or high inflation.
The second issue is in deciding how much money the investor should invest in a particular asset. The amount of money to be invested initially and in the future depends on the assessment the investor has of short-term and long-term economic trends.
In the previous chapters we have presented indicators that help investors recognize important economic trends and possible areas of risk and opportunities. At the end of the analysis of the main economic indicators, they were summarized in three main groups: leading, coincident and lagging indicators. It was also suggested that the growth of the economy, relative to its long-term average, has an important impact on the financial markets and the overall investment climate. The relative movement of the leading, coincident, and lagging indicators, and of the economy relative to its growth potential, affects short-term investment decisions.
These decisions are the outcome of the answer to questions such as: What should I do now? What should my strategy be in the coming months? What is the asset that offers the greatest opportunities and least risk, depending on the phase of the business cycle?
In the following chapters we will analyze in more detail each particular asset and how its price is affected by the business cycle itself. However, before beginning that discussion, it is important investors gain an appreciation and understanding of the broad, long-term economic trends. The first issue investors need to be aware of is to understand the kind of economic times they are living in.
(From Chapter 5 of my book Profiting in Bull or Bear Markets. Published also in Mandarin and on sale in China. The book is available at Amazon.com).
George Dagnino, PhD Editor,
The Peter Dag Portfolio.
2009 Market Timer of the Year by Timer Digest
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