Getting the best time to invest in the stock market is an intensively researched subject. More experienced investors know that getting the time to market right, or market timing in English is extremely difficult anywhere in the world. However, in Brazil, there is a factor that explains very well when you should increase your investment in the stock market and any investor has access.
There are four factors that explain the value of any asset: revenue growth, margin evolution, investment needs and interest rate.
To understand how market prices should evolve, market analysts create scenarios for each of these factors.
Thus, the higher the growth in revenues and margins, the higher the price of an asset should be. Therefore, the stock market tends to rise if there is economic growth.
However, we know that predicting economic growth is not an easy task. Additionally, the price of an asset would only rise if growth was not accompanied by a worsening of other factors.
Predicting the evolution of margins and the need for investment is something much more difficult, as it depends on the analysis of the competitive environment, new technologies and regulation.
Therefore, trying to predict the market with these variables is complex for the average investor.
No single factor is always effective in predicting the direction of the stock market, however, there is one that can be simpler to follow and with a higher success rate.
I think you already understand which factor I’m referring to, because there’s only one left.
The best and most accessible factor for predicting market direction is interest rate direction. Before I explain, see in the figure below how this relationship has been very strong for the last two decades.
The graph above shows the return of the Ibovespa in the following 12 months in the orange line. Thus, each point represents the return of the Ibovespa in the 12 months following the date on which the point is.
The blue line on the chart represents the Selic rate direction. Note, that the scale for this data is inverted on the right side of the graph. So, when interest rates rise, the stock market tends to fall, and when interest rates fall, the stock market tends to rise. As the scale is inverted, when the blue line is going down, it means interest rates going up and vice versa.
The Selic direction is calculated on the chart by simply subtracting the Selic rate for the following 12 months from the Selic rate for the previous 12 months. Therefore, it is very simple and affordable for any investor.
To assess the fair value of an asset, analysts calculate the company’s cash flows at present value. The interest rate is the element that discounts cash flows to present value. Therefore, the higher the interest rate, the lower the price.
Now you know which is the simplest factor to follow and how to follow up.
Therefore, the best time to increase exposure on the stock market is after the Central Bank interrupts the cycle of rising interest rates. In general, some time after interest rates are interrupted, they are reduced by the monetary authority.
The next meeting of the Monetary Policy Committee (COPOM) will take place on September 21. There is still the possibility of a further interest rate hike at this meeting. We will follow closely, as this could be an opportunity.
Michael Viriato is an investment advisor and founding partner of Investor’s House
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