It is always interesting to see how people, and the media in particular, can get confused between the markets and the recession. Understanding the difference and how they interact will enable you to understand what you should be doing with your investments, and how you can take advantage of how markets move.

The markets - in this case I am referring to the equity markets; gilts, bonds and property are slightly different. The markets as a general rule move ahead of any economic situation. They tend to anticipate what's coming. Of course they don't always get it right, but about 80% of the time they move in anticipation of economic (and political) events.

The economy moves based upon the simple results of supply and demand. When demand is high, the economy grows; when demand falls, the economy falls. These events can tend to be self-perpetuating, so if people generally are feeling pessimistic, they will cease spending and will save instead. This has the effect of reducing demand, hence the economy then reduces in size (a recession). This in turn has the effect of making people feel down, especially if the media keep on about it all the time, and so they spend even less, which affects the economy again, and round and round it goes.

If the markets believe that conditions are going to worsen in the economy, then people will sell stocks to move out of companies because they believe that they will make less money in the future. Hence, the supply of stocks to the market increases and so price falls. As price falls people get worried and so they sell more stocks, which reduces price further, and so round and round the markets go, too.

These are not new phenomena; it has been this way for over four hundred years. The difference now is that we are more aware of it because of the media and 24-hour cycles, so the cycles happen more quickly than they used to, even compared to just 10 years ago.

Of course, the reverse is also true, in that if markets can fall quickly, they can also rise quickly. They will rise quickly because the markets will anticipate improvements in the economy, and so will start to buy stocks again in the expectation that companies will be making money again soon.

The first stocks that recover are the smaller companies. Previosly we have explained that to predict market movements, you must look at smaller companies' stocks as these generally tend to move ahead of the markets, up or down, but predominantly when stocks go up.

At the time of writing, the FTSE smaller companies are up by 37% from their 52-week low, compared to the FTSE 100 which is up 30%. This tells us two things. Firstly, the markets are anticipating an improvement in the economy because the smaller companies are growing more than the larger companies, and secondly, that the markets are up!!

30% to 37% growth in the markets since their low! Do you remember when the press printed every day how many billions were wiped off the stock market when stocks fell? It seemed every day they gorged themselves on the bad news. When did you see a headline proclaiming 'billions gained in the stock market'? Of course you didn't.

From an investor's point of view this is a good thing. We have had a bad 10 years in the stock market, but if we can take advantage of the gains that will now happen we can make our investments move in the right direction.

As we pointed out last month, now is the time to take advantage of these movements by increasing the risk on your portfolios. This initial risk increase should stay in place for the next 9 to 12 months, when you should review things again. The reason for this? Why, the bloodbath that will be the next election