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1 Crucial Investing Tip: Don’t Confuse Economics with Investing

Here’s an investing tip for you to consider: Don’t invest based on broad macroeconomic trends. Economics and investing don’t mix.

Currency trends can be no big deal

The Brazilian real has fallen drastically against the U.S. dollar over the past five years since December 2010. To that point, one U.S. dollar could be swapped for 1.7 reals back then while the same dollar can get you 3.8 reals today.

This currency trend, along with disappointing economic growth in Brazil, has led to the dollar-denominated iShares MSCI Brazil Index ETF – an index tracking the Brazilian stock market – to crash by 72% over the same period.

Given such a backdrop, you might imagine that a company like Mercadolibre would have been a horrible investment over the last five years.

The company, which runs e-commerce marketplaces in Latin America, is listed in the U.S., reports in the U.S. dollar, and had seen Brazil account for at least 44% of its total revenue in each year from 2010 to 2014.

Year % of Mercadolibre’s revenue coming from Brazil
2010 57%
2011 56%
2012 48%
2013 44%
2014 49%

Source: S&P Capital IQ                                                            

But, Mercadolibre’s shares have risen by 73% in the same time that the iShares MSCI Brazil Index ETF had lost 72%. This had happened with a near-doubling of the company’s profit from US$56 million in 2010 to US$101 million in the last 12 months.

Broad macro trends – like subpar economic growth in Brazil and a free-falling real – couldn’t dent Mercadolibre’s business growth. Anyone who might have been spooked out by Brazil’s ailing macroeconomic conditions would have missed out on the strong gains posted by Mercadolibre.

Rising commodity prices need not save commodity stocks

Here’s another example of the wide gap that can exist between economics and investing. From 30 September 2005 to 15 September 2015, the price of gold in Australia had stepped up by nearly 10% annually from A$620 per ounce to A$1,550.

But, Australian gold mining stocks have been horrible investments over that same period – the S&P / ASX All Ordinaries Gold Index, an index made of Australian gold mining stocks, had ended up falling from 3,372 points to 2,245. Those who were lured by rising gold prices in Australia would have been crushed by the gold miners.

What to beware now

One of the biggest macro stories of the year has been the drastic fall in the price of oil. It has caused many oil & gas stocks to fall in tandem. It’s easy to imagine that oil & gas stocks would start climbing again if the price of oil were to recover.

But, it can be a mistake to buy oil & gas stocks blindly in the hopes of hitching onto a rebound in oil prices. That’s because no one knows when – or even if – the price of oil will rebound. But even if we assume that oil will surely bounce back up again in the future, there may be some oil & gas stocks that will have been destroyed, or become a pale shadow of their former selves, before any jump in the price of oil can happen.

The oil & gas stocks that may be most at risk are those which are heavily in debt, like for instance, Vard Holdings Ltd (SGX: MS7), EMAS Offshore Ltd (SGX: UQ4), and Ezion (SGX: 5ME). Based on their latest finances, the trio all have net-debt (total borrowings minus total cash) to equity ratios of more than 100%.

Company Net-debt to equity ratio (last 12 months)
Vard 301%
EMAS Offshore 127%
Ezion 104%

Source: S&P Capital IQ

An economic trend and a stock’s performance can be miles apart. Bear this in mind when you invest.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Mercadolibre.