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Fin2802: Investments
Spring, 2010
Dragon Tang
Lecture 16
Macroeconomic and Industry Analysis
March 23, 2009
Readings: Chapter 17
Practice CFA Problem Sets: 4,6,9,12,15
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The Greenspan/Bernanke Put
• Investors hold a put option from the Fed/Government
• When market drops, government rescues
• What’s the problem?
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Current Problem
•
•
•
•
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Long term vs. short term
Growth vs. inflation
Trust vs. gaming
…
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What is this?
•
•
•
•
What’s daily trading volume of US stock market?
What’s daily trading volume of US Treasury bonds?
Total market size $250.8 trillion
Daily trading volume $1.8 trillion
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What is this?
• What’s daily trading volume of US stock market?
– $10 billion
• What’s daily trading volume of US Treasury bonds?
– $300 billion
• Total market size $250.8 trillion
– Interest rate derivatives
• Daily trading volume $1.8 trillion
– Foreign exchanges
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“The actual interest rate forecast record of the
world's highest paid financial ‘experts’ for
forecasting interest rates is nothing short of
disastrous.”
http://www.opalmagazine.com/members/_financial_arti
cles/articles/Wall_March-2001_files/Wall_March2001.htm
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Macroeconomic and Industry Analysis
Objectives:
•
Effect of monetary and fiscal policies
•
Economic indicators (leading, coincident, and lagging)
•
Business cycles
•
Effect of industry life cycles and structure
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Fundamental Analysis
• Economics
– Investment and consumption
• Finance
• Accounting
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Geography and Finance
Internet:
Google
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Framework of Analysis
• Fundamental Analysis
• Approach to Fundamental Analysis
– Domestic and global economic analysis
– Industry analysis
– Company analysis
• Why use the top-down approach
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Finance and Growth
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Shocks to Finance and Growth
Shock to
stock market
Shock to
macroeconomy
Stock Market
Macroeconomy
Shock to both
stock market and
macroeconomy
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Global Economic Considerations
• Performance in countries and regions is
highly variable
• Political risk
• Exchange rate risk
– Sales
– Profits
– Stock returns
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Change in Real Exchange Rate:
Dollar Versus Major Currencies. 1999-2003
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Key Economic Variables
•
•
•
•
•
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Gross domestic product
Unemployment rates
Interest rates & inflation
Budget Deficits
Consumer sentiment
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S&P 500 Versus EPS Estimate
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Determination of the Equilibrium Real Rate of Interest
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Federal Government Policy
• Fiscal Policy - government spending and
taxing actions
– Direct policy
– Slowly implemented
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Federal Government Policy (cont.)
• Monetary Policy - manipulation of the money
supply to influence economic activity
– Initial & feedback effects
• Tools of monetary policy
– Open market operations( federal funds rate)
– Discount rate
– Reserve requirements
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Demand Shocks
• Demand shock - an event that affects demand
for goods and services in the economy
– Tax rate cut
– Increases in government spending
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Supply Shocks
• Supply shock - an event that influences
production capacity or production costs
– Commodity price changes
– Educational level of economic participants
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Business Cycles
• Business Cycle
– Peak
– Trough
• Industry relationship to business cycles
– Cyclical
– Defensive
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NBER Cyclical Indicators: Leading
Leading Indicators - tend to rise and fall in
advance of the economy
Examples
–
–
–
–
Avg. weekly hours of production workers
Stock Prices
Initial claims for unemployment
Manufacturer’s new orders
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NBER Cyclical Indicators: Coincident
Coincident Indicators - indicators that tend to
change directly with the economy
Examples
– Industrial production
– Manufacturing and trade sales
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NBER Cyclical Indicators: Lagging
Lagging Indicators - indicators that tend to
follow the lag economic performance
Examples
– Ratio of trade inventories to sales
– Ratio of consumer installment credit outstanding
to personal income
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Economic Calendar at Yahoo!
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Industry Analysis
• Sensitivity to business cycles
• Sector Rotation
• Industry life cycles
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Estimates of Earnings Growth Rates in Several Industries,
2004
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Sensitivity to Business Cycle
• Factors affecting sensitivity of earnings to
business cycles
– Sensitivity of sales of the firm’s product to the
business cycles
– Operating leverage
– Financial leverage
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Industry Cyclicality
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A Stylized Depiction of the Business Cycle
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Figure 17.6 Returns on Equity, 2005
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Figure 17.7 Rate of Return, 2005
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Sector Rotation
• Selecting Industries in line with the stage of
the business cycle
• Peak – natural resource firms
• Contraction – defensive firms
• Trough – equipment, transportation and
construction firms
• Expanding – cyclical industries
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Sector Rotation Gains
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Historical Sector Performance
Total returns on a representative group of Fidelity Select funds from
1999 to 2003 (fund with highest return for the year in blue).
Yr
Biotech
Finance
1999
2000
2001
2002
2003
77.8%
32.8%
-25.0%
-40.5%
32.9%
30.6%
28.3%
-9.2%
-17.2%
36.5%
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Const.
Media
12.5% 44.1%
8.8% -23.1%
20.0% -1.0%
-8.5% -12.8%
44.1% 43.9%
Gas
Tech
Wilshire
26.2%
71.0%
-22.9%
-9.6%
28.7%
132.4%
-31.8%
-31.7%
-37.8%
59.4%
23.6%
-10.9%
-11.0%
-20.9%
31.6%
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Industry Life Cycles
Stage
Start-up
Consolidation
Maturity
Relative Decline
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Sales Growth
Rapid & Increasing
Stable
Slowing
Minimal or Negative
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The Industry Life Cycle
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Practice
Choose an industry and identify the factors that will
determine its performance in the next three years. What is
your forecast for performance in that time period.
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Case Analysis: Tech Bubble/Bust and the Fed
• 1990s—especially second half—saw dramatic rise in stock
prices
– Growth in real GDP averaged 4.2% annually from 1995-2000
• Technological changes of 1990s were an example of a shock
to both stock market and economy
• The market—especially high-tech NASDAQ stocks—began to
decline in early 2000
• Faced with these demand shocks, Federal Reserve would
ordinarily have raised its interest rate target to prevent real
GDP from exceeding potential output
• Fed increased rates 6 times in 1999 and 2000 from 5% to
6.5%, then reduced rates 11 times in 2001 to 1.75% (1.00%
by 6/25/2003)
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The Fed’s Problem In 2000: An AS-AD View
(a)
(b)
If output exceeds potential,
the self-correcting
mechanism AS
Price
2
will raise
the
price
level
further
Level
Price Wealth effect of rising
Level stock prices shifts AD
rightward, raising real
AS
GDP and the price level
AS1
P3
B
P2
P1
C
P2
A
AD2
B
AD1
Y1
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Y2
Real GDP
Chapter 17: Macroeconomic and Industry Analysis
AD2
A
P1
AD1
Y1
Y2 Real GDP
41
The Fed’s Problem in 2000: A Phillips Curve View
(a)
Inflation
Rate
(b)
If the natural rate of
unemployment is 4%, the
Fed can keep the economy
at point A in the long run
2.5%
Inflation
Rate
5.0%
A
2.5%
1.5%
PC1
4% Unemployment
Rate
UN?
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C
A
But if the natural
rate is above 4%
the Phillips curve
will shift upward
and the Fed must
choose between
higher inflation . . .
D
B
. . . or recession
PC1 PC
2
4% 5% Unemployment
Rate
UN?
42
The Fed and the Stock Market
•
Might think Fed can estimate natural rate by a process
of trial and error
–
•
However, Fed looks ahead and determines whether
current economic conditions are likely to raise inflation
rate in the future
–
–
–
•
Bring unemployment rate to a certain level (such as 4%) and see
what happens to inflation
By raising interest rates to rein in the economy, Fed also brought
down stock prices
By 2001, high-tech bust, recession of 2001, and attacks of
September 11 brought criticism to an end
As the economy began a slow expansion, in 2002 and early 2003,
Fed kept the interest rate low
Unresolved question: Who should be setting the general
level of share prices—millions of stockholders who buy
and sell shares, or Federal Reserve?
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Summary
•
•
•
•
•
FIN 2802, Spring 10 - Tang
Economic environment
Monetary and fiscal policies
Economic indicators
Business and industry cycles
Next: Asset Pricing Theory
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