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CHAPTER 17 Macroeconomic and Industry Analysis Investments, 8th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Framework of Analysis • Fundamental Analysis • Approach to Fundamental Analysis: – Domestic and global economic analysis – Industry analysis – Company analysis • Why use the top-down approach? 17-2 Global Economic Considerations • Performance in countries and regions is highly variable • Political risk • Exchange rate risk – Sales – Profits – Stock returns 17-3 Table 17.1 Economic Performance in Selected Emerging Markets 17-4 Figure 17.1 Change in Real Exchange Rate: U.S. Dollar versus Major Currencies, 1999–2006 17-5 Key Economic Variables • • • • • Gross domestic product Unemployment rates Interest rates & inflation Budget deficit Consumer sentiment 17-6 Figure 17.2 S&P 500 Index versus Earnings Per Share 17-7 Demand Shocks • Demand shock - an event that affects demand for goods and services in the economy 17-8 Supply Shocks • Supply shock - an event that influences production capacity or production costs 17-9 Federal Government Policy • Fiscal Policy: Demand-side management – Tax rate cut – Increases in government spending 17-10 Federal Government Policy Continued • Monetary Policy - Demand-side management – Manipulation of the money supply to influence economic activity • Initial & feedback effects • Tools of monetary policy –Open market operations –Discount rate –Reserve requirements 17-11 Federal Government Policy Continued • Fiscal Policy: Supply-side management – Incentive or marginal taxes • National policies on education, infrastructure, and research are important elements 17-12 Business Cycles • The transition points across cycles are called peaks and troughs – A peak is the transition from the end of an expansion to the start of a contraction – A trough occurs at the bottom of a recession just as the economy enters a recovery 17-13 Figure 17.3 Cyclical Indicators 17-14 Leading Indicators • Leading indicators tend to rise and fall in advance of the economy • Examples: – Avg. weekly hours of production workers – Stock Prices 17-15 Table 17.2 Indexes of Economic Indicators 17-16 Coincident Indicators • Coincident Indicators - indicators that tend to change directly with the economy • Examples: – Industrial production – Manufacturing and trade sales 17-17 Lagging Indicators • 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 17-18 Figure 17.4 Indexes of Leading, Coincident, and Lagging Indicators 17-19 Table 17.3 Economic Calendar 17-20 Industry Analysis • Sensitivity to business cycles • Factors affecting sensitivity of earnings to business cycles: – Sensitivity of sales of the firm’s product to the business cycles – Operating leverage – Financial leverage • Industry life cycles 17-21 Figure 17.5 Economic Calendar at Yahoo! 17-22 Table 17.4 Useful Economic Indicators 17-23 Figure 17.6 Return on Equity, 2007 17-24 Defining an Industry • North American Industry Classification System, or NAICS codes – Codes assigned to group firms for statistical analysis 17-25 Figure 17.7 Industry Stock Price Performance as Measured by Rate of Return on Dow Jones Sector iShares, January-October 2007 17-26 Figure 17.8 ROE of Major Banks 17-27 Table 17.5 Examples of NAICS Industry Codes 17-28 Figure 17.9 Industry Cyclicality 17-29 Table 17.6 Operating Leverage of Firms A and B Throughout the Business Cycle 17-30 Figure 17.10 A Stylized Depiction of the Business Cycle 17-31 Sector Rotation • Portfolio is adjusted by selecting companies that should perform well for the stage of the business cycle – Peaks – natural resource extraction firms – Contraction – defensive industries such as pharmaceuticals and food – Trough – capital goods industries – Expansion – cyclical industries such as consumer durables 17-32 Figure 17.11 Sector Rotation 17-33 Industry Life Cycles Stage Sales Growth Start-up Consolidation Maturity Relative Decline Rapid & Increasing Stable Slowing Minimal or Negative 17-34 Figure 17.12 The Industry Life Cycle 17-35 Industry Structure and Performance • • • • • Threat of entry Rivalry between existing competitors Pressure from substitute products Bargaining power of buyers Bargaining power of suppliers 17-36