When sellers are in the majority, it all happens in reverse. Prices fall, along with the will to get in and
buy. Whether it's shares or houses or bananas, the same market principles apply - sagging demand means suppliers receive less for their products and their sales and profits decline. That in turn means job layoffs, which leads to even less spending.
Most of us are aware by now of the serious economic woes that led to the current global economic downturn. The slide began when a slowing housing market and rising interest rates led to over-extended borrowers not being able to maintain their mortgage payments. As credit began to tighten up, the knife cut deeper. Financial institutions failed, property and share prices plummeted. Just how far the damage will spread is still not known.
But if what goes up must come down, then for most markets, the reverse is also true. (This is especially so for sharemarkets, which are often considered a leading indicator of a country's economic strength and development). What we are currently experiencing may rank among the worst global economic shocks of all time, but history provides ample evidence that recovery will occur in time.
So what is needed for that to happen? How does 'fall' become 'rise' again? How do markets recover?
Simply, markets recover when demand starts to pick up again. Demand expansion can spring from a number of sources, principally consumption, investment, government stimulation (via purchasing) and exports. These are all activities in what is sometimes called the 'real' economy. The real economy is based on productivity - actual products and services that are sold around the world.
"In actual fact, sharemarkets typically recover when the news gets 'less' worse," explains ING's Chief Investment Officer, Philip Houghton-Brown. "By the time the good news starts to filter through, sharemarkets will already be well on the way toward recovery."
Consumer confidence was mostly well down during 2008, yet it did respond positively in response to interest rate cuts and tax cut news towards year's end. Consumer spending is a very important ingredient in the recovery recipe. John Keynes, an influential 20th century British economist, described the reluctance of people and businesses to spend during tough times as the 'paradox of thrift', because it only aggravated the problem of an economic slowdown.
One thing that we as New Zealand Consumers can do to help in this regard is to maintain buying patterns,and to buy local. Buying products and services from companies listed on the New Zealand Stock Exchange serves as a direct stimulus to the national economy.
However, for some of us a recession is a reminder that it's always important to also put something away. While a complete halt in spending is not good for the economy, arguably it was over-spending with little or no saving that has contributed to the economic situation we're now facing.
Investment activity tends to pick up more slowly, both from personal and business investors. Factors such as falling house prices and job insecurity have reduced personal investment significantly, while credit difficulties have had a similar effect on business investors.
However, a severe economic downturn does, by its very nature, create one thing that is attractive to investors - low prices. In the case of the sharemarket, the other vital ingredients are an improvement in company earnings and investor confidence. As long as these are all in place, recovery will reward the patient long-term investor.
Government intervention has occurred all around the world to an unprecedented degree in the wake of the current crisis. Our own government's package seems very small in comparison to the multi-trillion dollar stimulus package in the US, but some positive effects are already being felt. Besides, as Finance Minister Bill English has pointed out, the US has had to deal with far more volatility in its financial sector, whereas ours has been relatively stable.
Tax cuts and planned government infrastructure spending, together with Reserve Bank interest rate cuts, will all serve to increase money supply and to lubricate the economic engine.
Finally, there are exports. The term 'export-led recovery' has been heard a lot lately. Tim Gibson, CEO of New Zealand Trade and Enterprise, has been very bullish about the prospects of an export-led recovery. Although not everyone shares that view.
Says Dr Ganesh Nana of BERL (Business and Economic Research Limited): "An export-led recovery must await a recovery in global demand, which does not appear to be an immediate prospect."
So the precise nature and timing of the recovery is difficult to predict. But if we follow history's lead, we can only assume that it will occur, and a lot of effort is being made for that to happensooner rather than later.
Read the full Quarterly Investor Focus from ING here.