Download Chapter 11: Macroeconomic and Industry Analysis

Chapter 11: Macroeconomic and Industry Analysis
Outline:
I.
II.
III.
The Global Economy
The Domestic Economy
Industry Analysis
Motivation:
- A top-down process because of the fundamental impacts of macroeconomic and
industrial effects on individual securities.
- How about those firms that use bottom-up approach?
I. The Global Economy
Why top-down approach? The reasons are: (1) the macroeconomic and industrial
environment has a significant effect on individual firms’ earnings, (2) returns on
individual stocks are largely explained by returns on aggregate stock market and the
stock’s industry.
The international economy has impacts on national economy and a firm’s exports
prospects and foreign investments.
Exchange rate: the rate at which domestic currency can be converted into foreign
currency.
Through exchange rate fluctuations, the global economy also has impact on the price
competition a firm faces from foreign competitors.
-----------------------------------------------------------------------------------------------------------Global Asset Allocation: Non-US Equities Better Positioned for Oil Shock
Hernando Cortina
Oil shock unwelcome, but no change in views: Expect global equities to outperform cash
into year end and cash to outperform bonds. Spike supports relative preference for equities
outside the U.S. over U.S. stocks.
Global equities are not priced for strong growth: Global growth continues to look resilient
and even if it slows from above-trend to trend, equities are already priced for a more dire
scenario. Global forward P/E is near 15-year low with modest embedded expectations.
Buy Japanese and EM equities on dips: Commodity exposure, restructuring, and relative valuations imply
significant differences in regional risk/reward, with Japan and EM looking relatively more attractive and the U.S.
looking relatively less attractive.
Risks: The latest round in the oil shock raises the risk of a slowdown in the pace of global growth. Overweighting
Japanese and EM equities should improve the odds of outperforming should the impact start to become more
visible in the U.S.
------------------------------------------------------------------------------Source: Morgan Stanley
II. The Domestic Macroeconomy
When the domestic economy is good (poor), most stocks yield good (poor) returns.
Therefore, a good understanding of domestic economic conditions may help one to time
the market and select securities.
What are the relationships between stock market returns and the following key economic
statistics?
Interest rate: the cost (benefit) of borrowing (saving).
- Monetary policy.
Inflation: the rate at which the general level of prices for goods and services is rising.
Unemployment rate: the rate of the number of people classified as unemployed to the
total labor force.
Budget deficit: the amount by which government spending exceeds government
revenues.
- Fiscal policy.
Trade deficit: imports − exports.
Sentiment and confidence: e.g., consumer confidence.
Gross domestic product: the market value of goods and services produced over a period
of time.
- Business cycle: repetitive cycles of recession and recovery.
- Peak: the transition from the end of an expansion to the start of a contraction.
- Trough: the transition point between recession and recovery.
- Cyclical industries: industries with above-average sensitivity to the state of the
economy.
- Defensive industries: industries with below-average (I think “negative” is better)
sensitivity to the state of the economy.
Leading economic indicators: economic series that tend to rise or fall in advance of the
rest of the economy.
- Can we use leading economic indicators to predict stock markets?
- Can we use stock returns to predict the economy or even some leading economic
indicators?
- Table 11.2, p. 368.
III. Industry Analysis
One may use Standard Industry Classification (SIC codes) to define industry groups.
One important aspect of industry analysis is to study the relationship between industry
performance and the state of the macroeconomy.
Sector rotation: an investment strategy that entails shifting the portfolio into industry
sectors that are expected to outperform others based on macroeconomic forecasts.
1. Toward the end of a recession, financial stocks tend to be good buys because (1) lower
inflation and lower interest rate, and (2) the investors anticipate that financial firms’
earnings will rise as both the economy and financial activities (loan demand) recover.
2. At the trough of a recession, capital goods stocks, e.g., equipment, transportation, and
construction are good buy because firms might anticipate a better economy and are more
milling to invest.
3. Once the economy begins its recovery, consumer durable stocks (cars, computers,
electronics) tend to be good buys. A reviving economy will increase consumer
confidence and personal income.
4. At the peak of the business cycle, basic industry stocks (oil, gold, aluminum, timber)
tend to be good buys. They are more inflation-proof.
5. During a recession, it is difficult to find good buys. Nevertheless, consumer staples
stocks (pharmaceuticals, food, and beverages) tend to be able to hold their market prices.
These are usually called “defensive” industries.
Industry Life Cycle:
1. Start-up stage: rapid and increasing growth in sales.
2. Consolidation stage: stable growth in sales.
3. Maturity stage: slowing growth in sales.
4. Relative decline stage: minimal or negative growth in sales.
Question: arguably, computer manufacturing industry begins entering the maturity stage
of its life cycle. What would you expect about the industry’s sales growth, profit margin,
competition? What kinds of computer manufacturing stocks are more likely to be the
winners?
End-of-chapter problem sets: #2, #3