Financial News & TipsAlan S. Moore / L’Observateur / December 15, 1999Do you often stop paying attention to the TV news because once again commentators are going on about inflation, securities prices and interest rates? All this talk about the economy can be confusing, and it’s tempting to just tune it out. However, as a retirement investor, you might benefitfrom some basic information about economic trends and how they affect your investments.

Published 12:00 am Wednesday, December 15, 1999

The Business Cycle The economy goes through stages of prosperity that are often referred to as the business cycle. While cycle implies a regularly repeated pattern,the economy is anything but predictable. Usually, there is an initial periodof rapid economic growth, followed by a period of slow growth or even stagnation. The length of the economy’s expansions and contractions hasvaried over the years.

Stocks and the Economy The economy and the stock market are closely connected. During periods ofeconomic prosperity, consumer demand for goods and services typically leads to increased sales and higher profits for businesses. Stock prices asa whole tend to rise. Periods of recession have the opposite effect. Salesbecome sluggish or decline and typically lead to diminished earnings.

During periods of economic downturn, stock prices tend to fall.

Cyclical industries, such as automobile manufacturing and home construction, tend to move with the economy. Car sales and housing startscan vary significantly from year to year because consumers can defer purchases of high-price items like these from one year to the next.

Consumer staples stocks, such as food companies, tend to be more stable, even when the economy is in a recession. While a family might do withoutcertain luxury items during a recession, they can’t go without buying groceries. Stocks in growth industries tend to do well during periods ofeconomic expansion.

Bonds and Interest Rates The Federal Reserve is the central bank of the United States. When the Fedbelieves that the economy is expanding too quickly, it may raise certain short-term interest rates to help keep inflation under control. Inflation isan overall increase in prices of all goods and services resulting in the decline in the purchasing power of the dollar. If the economy is in a slump,the Fed may reduce certain short-term interest rates to make borrowing more affordable and stimulate business and consumer spending.

Higher interest rates are usually bad news for bonds, especially long-term bonds. As market interest rates rise, existing bonds pay a lower interestrate than newly issued bonds. As a result, the market price of existingbonds goes down. However, bond prices usually rise as interest rates fall.

Your Investment Strategy While it’s helpful to understand the effect of economic trends on your investments, it is not a good idea to alter your investment strategy based solely on changes in the current economy. As a long-term investor, anychanges to your portfolio should be based on your risk tolerance, your personal goals, and the amount of time you have before you retire.

A Few Definitions

Bear Market – an extended period of declining stock prices

Bull Market – an extended period of rising stock prices

Consumer Price Index – a measurement of changes in the cost of living for consumers

Dow Jones Industrial Average – an index that measures the general level and movement of 30 blue chip stock prices

Federal Reserve – the central bank of the United States

Gross Domestic Product – a measurement of the value of goods and services produced in the country

Inflation – an overall increase in the prices of goods and services

Market Risk – fluctuations in the market prices of securities over time

New York Stock Exchange – the largest organized stock exchange in the United States

Recession – a period of rising unemployment and declining national output

(Alan S. Moore is a financial advisor of Legg Mason Wood Walker, Inc., a diversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.)

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