Profit By Understanding Fundamental Trends
Fundamental trends are movements in the overall economy- in either a single country or the entire world - that help to shape financial markets and consumer trends. Investment dealers, business owners and even governments analyze these trends in order to predict future corporate growth and consumer preferences.
Missing a fundamental trend or interpreting one incorrectly can result in volatility in the markets and inflated stock and commodity prices. (With the market in constant change on a per second basis it is import to know what effect this has on returns, to learn more Volatility's Impact On Market Returns.)
What Makes a Trend Fundamental?
Many factors influence financial markets. Some of those factors are temporary in nature, including war, spikes in costs of inputs and political instability. These short term trends can have dramatic impacts on share prices and liquidity in the markets.
Fundamental trends, however, are more permanent in nature. They show shifts in underlying views, technologies and knowledge and will move the markets more slowly yet more enduringly.
Living Standards in China
An example of a fundamental trend happening in the world this decade is the rising lifestyle standards in China and the skyrocketing consumer demand there for Western goods. The demand in China for cars, meat, electronics and appliances stems both from increasing exposure to Western advertising and an overall increase in the Chinese standard of living. What makes this a fundamental trend is that there is no going back. Once a country raises its standard of living and becomes more globally aware, it changes consumer spending patterns forever. (For a greater idea of what factors increase a countries standard of living, read Standard Of Living Vs. Quality Of Life.)
Canned Food
Another, more historical, example was the innovation of food transportation by the Union army in the Civil War. Although canned food had been available prior to the war, the canning process was perfected and expanded and a complexlogistics mechanism put in place to distribute rations to the soldiers. After the war, food distribution changed forever and it could be shipped all over the Union, increasing the variety of food choices available everywhere.
Trend Drivers
The underlying drivers of fundamental trends can include leaps in innovation, scarcity of resources, national economic advancement and even changes in consumer tastes. The latter one is exemplified by the trend away from wearing animal fur. The once booming industries of trapping and farming fur animals have died out almost completely. Consumers now opt for less expensive synthetic materials for coats and other outerwear. This trend is unlikely to reverse although it may once again evolve into new directions. (Trends are always occurring; to help you identify them, check out 4 Factors That Shape Market Trends.)
The Impact of Fundamental Trends on Financial Markets
In a perfect economic world, fundamental trends would be the only market movers as they represent true and ongoing change. Although some of these trends can happen practically overnight (like the first split atom), most occur over time, thereby giving forecasters time to adapt to the changes.
The efficient market theory stipulates that fundamental trends are public knowledge and are therefore incorporated into current market and futures pricing. If this was the only input into market pricing, the financial markets would move smoothly and fluidly. However, other market influences come into play constantly. These sudden pushes and pulls on pricing can either amplify or dampen the effect of fundamental trends on the markets.
Lessons From Oil
Take, for example, the impact of federal subsidies to the oil industry. The rate of growth in consumer demand in North America for petroleum-based fuels has decreased over the past decade as more efficient vehicles are built and more environmentally-sustainable technologies come online. However, the U.S. oil industry is heavily subsidized which allows it to continue to grow and to keep prices at artificial lows. Low prices for oil keep consumers and manufacturers from investing in new technologies to move away from oil. This is an artificial boost in the arm of the industry that will not be sustainable in the long run, without continued injections of billions in tax dollars. (To learn more about the oil companies and the advantages the government gives them, check out A Guide To Investing In Oil Markets.)
The Dangers of Ignoring Fundamental Trends
Regardless of other short-term market forces, fundamental trends are still one of the most important drivers of financial markets in the long run. Stock brokers, commodity traders and even individual investors must follow these trends in order to predict future valuations. Some trends impact the entire market and some only certain industries. The latter most often occurs when there has been a technological breakthrough in manufacturing or processing, such as the invention of the cotton gin.
Fundamental trends can impact both the supply and the demand side of the markets. They can increase supply when the trend improves efficiency in production or distribution of products or services. For example, the trend towards the online provision of bookkeeping services allows providers to offer their services all across the world rather than be confined to a more local market. The ultimate result is that the price of bookkeeping services drops across the industry with the increased competition. (To learn more on how the supply side can affect the entire economy, read Understanding Supply-Side Economics.)
Demand is impacted when the trend derives from consumer preferences. An example of this is the move towards healthier and organic foods. The food industry did not start the trend but rather medical reports and health industry news sparked an increase in demand for these foods.
Companies that ignore fundamental trend analysis do so at their own risk. Those who take advantage of shifting underlying economic markers can position themselves ahead of their competitors. Watching changes in markets allows a company to shift strategy and invest in new technology to provide new products and services to new markets. Companies who forgo this analysis often find themselves the dinosaurs of their industry, doing things the same way they have always done, unaware that the market has moved on.
The Publishing Industry's Tale
An example of an industry struggling to counteract the effects of a fundamental shift is the book publishing industry. Electronic books (ebooks) had been around for many years but gathered steam from 2009-2011. Traditional publishing houses almost unilaterally rejected the ebook, postulating that it would never take over from print. While they should have been hitching a ride on the train barreling down the tracks at them, they instead argued that it was not a train at all. Many of the large publishers began dabbling in the ebook market, but they do not dominate it as their pricing and promotion strategies have not moved with the trend. (For more on companies which failed to change with the fundamental shifts in the market, read 5 Big Companies' Biggest Blunders.)
The Bottom Line
Fundamental trends are an important driver of financial markets and every investor and entrepreneur should analyze them on an ongoing basis. These trends signal underlying shifts in the economy that will have a large impact on future consumption. Missing these trends can result in poor portfolio performance or an outdated business model.
