What is the cockroach theory and how does it help my investing?


 

cockroaches, cockroach theory, property investing, interest rates,

The general reaction to seeing cockroaches

The general reaction to when someone mentions “Cockroaches!!

Economists say that cockroaches and interest rates have something in common. And its important to know if you are an investor!

It relates to the generally held notion that once you see one, it generally means you are likely to see another, and another, and so on!

So with the RBA recently announcing the first rate cut for well over 8 months, there is now wide held speculation there will be another rate cut by the end of the year. According to some economists it might be as soon as August and that would be another welcome boost to the property market.

To raise a interesting point, most economists before the rate cut were saying that the next interest rate movement would be up. So what happened to cause the general consensus to change so rapidly?

Well, that would be the April inflation figures and recent figures show there was a sudden dip from 2% to 1.5%. The long term target for the RBA is to keep inflation rates in the range of 2-3%.

Australia-core-cpi-Q1-2016

(c) Image courtesy of Business Insider 

RBA governor Glenn Stevens recently stated “continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand” in the RBA’s monetary policy statement for April.

And just to highlight, that cockroach theory is actually an actual economic theorem and its not just made up. It states “that unfavourable reports about a company will, once publicised, be followed by similar report about other companies in the industry“.

An example of this is Enron. While they were engaging in aggressive accounting practices that did not truthfully reflect their financial well-being, it was revealed that other companies were engaging in similar practices.

So for investors its important to that bad economic news maybe followed by further bad news. However know that the opposite is generally true and good economic signals could indicate there are further good economic signals ahead.

Forward this post to a friend. Let us know your view on this topic and leave a comment below.

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