Markets form wealth base

It’s important to understand how the share and property markets work

THE share and property markets form the foundation of the wealth of most Australians. Whether it be through direct investment in shares or property, or through super funds, they are the cornerstone of our net worth.

We are bombarded with analysis from an array of experts on why these markets are performing the way they are at any given moment.

In fact, there is so much opinion, data, analysis and comment, that we become buried in information and tend to over complicate how these markets operate and what drives them. That high level of complication can often drive people away from potentially a major driver of their wealth.

So let’s just strip back these markets to their basics.

A market place is simply an organised system to buy and sell assets. They’ve been around since mankind began as we traded goods and services between each other.

Today’s more sophisticated and electronic systems basically operate in the same way, matching suppliers of goods and services with buyers.

In this case, owners of shares and property with buyers.

History has also never changed the fact these markets are driven by supply, demand and psychology.

A balanced market is where supply of a product matches the demand for that product.

If supply is below demand then buyers will increase the price to entice the seller who will choose them rather than others to deal with. If supply is more than demand, then sellers will drop their price in the hope of enticing buyers to choose them rather than other competitors with a better deal.

That buying and selling of shares on the sharemarket is done through an organised electronic system operated by different stock exchanges around the world and regulated by Government authorities.

Stockbrokers act as agents for the buyers and seller.

With property, the market operates on a direct buyer to seller basis with real estate agents often (but not solely) acting as intermediaries. The market is somewhat regulated but not as tightly as shares.

The secret to making money is buy shares or property at low value and sell for a higher price. (We won’t overcomplicate the issue with things like short selling and options.)

To achieve a profit, investors need to assess likely future price movements based on current information. This is achieved by understanding what drives supply, demand and psychology.

DEMAND

In the sharemarket, demand for a stock is based around the likelihood of that company being able to increase sales and profits. The higher the profit, the more valuable the share and the more dividends distributed.

So investors look at what the company produces and whether customers are willing to buy that product or service.

If, for example, commodity prices like iron ore and coal rise in value that generally means a company like BHP will earn a

higher profit, pay more in dividends and other investors will want to buy their shares.

When it comes to property, demand from buyers is driven by many factors including the price range they can afford, access and cost of finance to fund the purchase, whether they have a job and immigration levels, which provide new outside purchasers.

SUPPLY

Companies have a limited number of shares available and their existing investors determine how many they are willing to put on the market to sell to others.

If a company’s prospects look good and lots of investors want to buy then they’ll have to offer more on the stock exchange auction to persuade existing shareholders to sell.

Or a company may issue more shares to raise money and add to the supply.

In property, supply is determined by the amount of existing houses and units up for sale, and the number which are being constructed.

That’s why all the experts watch figures like building approvals by councils and housing construction finance figures from banks as early warning signals as to the level of supply that is coming.

PSYCHOLOGY

What many forget is markets are simply an auction system run by people to allow people to trade goods and services.

So how buyers and sellers feel emotionally and psychologically also affects demand and supply.

If investors are gloomy because the economy is in recession, their job is uncertain or interest rates are high they won’t take risks and buy much. Therefore demand will be low and drive prices down.

If the economy is good, they feel safe in their job and money is cheap, they’ll be in a mood to buy.

Another important psychological factor in markets is uncertainty.

If buyers are not confident in the future, are unexpectedly surprised or feel threatened, back into the shell they’ll go. Markets hate uncertainty … that’s why they’ve been nervous about the China-US trade talks and whether the economy can continue to grow solidly. Obviously this is a simple explanation of how markets work. But it’s sometimes important to strip our thinking back to the fundamentals so our decision making isn’t blinded by complication.

The helicopter view often brings clarity.