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CHAPTER 17
Macroeconomic and Industry
Analysis
INVESTMENTS | BODIE, KANE, MARCUS
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
17-2
Fundamental Analysis
• A firm’s value comes from its
earnings prospects, which are
determined by:
– The global economic environment
– Economic factors affecting the
firm’s industry
– The position of the firm within its
industry
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The Global Economy
• Stock markets around the world
responded in unison to the financial
crisis of 2008.
• Performance in countries and regions
can be highly variable.
• It is harder for businesses to succeed in
a contracting economy than in an
expanding one.
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The Global Economy
• Political risk:
– The global environment may
present much greater risks than
normally found in U.S.-based
investments.
• Exchange rate risk:
– Changes the prices of imports and
exports.
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Table 17.1 Economic Performance
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The Domestic Macroeconomy
• Stock prices rise with earnings.
• P/E ratios are normally in the range of 1225.
• The first step in forecasting the
performance of the broad market is to
assess the status of the economy as a
whole.
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Figure 17.2 S&P 500 Index versus Earnings
Per Share
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The Domestic Macroeconomy:
Key Variables
•
•
•
•
•
•
Gross domestic product
Unemployment rates
Inflation
Interest rates
Budget deficit
Consumer sentiment
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Demand and Supply Shocks
• Demand shock - an
event that affects
demand for goods
and services in the
economy
• Supply shock - an
event that influences
production capacity or
production costs
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Demand-side Policy
• Fiscal policy – the government’s spending
and taxing actions
• Monetary policy – manipulation of the
money supply
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Fiscal Policy
• Most direct way to stimulate or slow
the economy
• Formulation of fiscal policy is often a
slow, cumbersome political process
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Fiscal Policy
• To summarize the net effect of fiscal
policy, look at the budget surplus or
deficit.
• Deficit stimulates the economy
because:
– it increases the demand for goods
(via spending) by more than it
reduces the demand for goods (via
taxes)
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Monetary Policy
• Manipulation of the money supply to
influence economic activity.
• Increasing the money supply lowers
interest rates and stimulates the
economy.
• Less immediate effect than fiscal policy
• Tools of monetary policy include open
market operations, discount rate,
reserve requirements.
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Monetary Policy
• Open Market Operations: The purchase and sale of government
securities that affect both interest rates and the amount of reserves
in the banking system
• Federal Funds Rate: The interest rate on overnight loans between
banks of their deposits at the federal reserve.
• Discount Rate: The interest rate that the Federal Reserve charges
banks on discount loans
• Reserve Requirements: Regulation making it obligatory for
depository institutions to keep a certain fraction of their deos its in
accounts with the fed.
• Monetary Base:
= Fed’s monetary Liabilities
+ US treasury’s monetary liabilities
=[Currency in circulation + reserves] + [Coins]
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FIGURE Structure and Responsibility for Policy Tools in the Federal
Reserve System (Mishkin)
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FIGURE 2 Federal Reserve System
Source: Federal Reserve Bulletin.
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Open Market Operations
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Federal Open Market Committee sets a target for the federal funds rate
↓
The trading desk at the Federal Reserve Bank of New York
[Purchases and sells U.S. and government Securities to achieve the federal funds rate target]
↓
Dynamic open market operations
(Change the level of reserves and MB)
and
Defensive open market operations
(Offset movements in other factors (float, treasury deposit, cash) that affects Reserves and MB)
For example, Public’s holding of currency ↑ → R↓→ purchase securities to ↑R
↓
The trading desk sends an electronic message to its primary dealers through the Trading Room Automated Processing System
(TRAPS) . The dealers are given several minutes to respond via TRAPS with their propositions. The desk selects all
propositions, beginning with the most attractively priced, up to point where desired amount is purchased or sold
Two types of temporary transactions
Repurchase agreement (repo)
(Fed purchases securities with an agreement that the seller will repurchase them in a short period of time)
Matched sale-repurchase transaction (reverse repo)
Fed sells securities and the buyer agrees to sell them back to the fed in the near future
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Supply-Side Policies
• Goal: To create an environment in
which workers and owners of capital
have the maximum incentive and
ability to produce and develop goods.
• Supply-siders focus on how tax policy
can be used to improve incentives to
work and invest.
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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.
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The Business Cycle
Cyclical Industries
Defensive Industries
• Above-average sensitivity
to the state of the
economy.
• Examples include
producers of consumer
durables (e.g. autos) and
capital goods (i.e. goods
used by other firms to
produce their own
products.)
• High betas
• Little sensitivity to the
business cycle
• Examples include food
producers and
processors,
pharmaceutical firms, and
public utilities
• Low betas
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Economic Indicators
• Leading indicators tend to rise and fall
in advance of the economy.
• Coincident indicators move with the
market.
• Lagging indicators change subsequent
to market movements.
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Figure 17.4 Indexes of Leading,
Coincident, and Lagging Indicators
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Table 17.4 Useful Economic Indicators
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Economic Calendar
• Many sources, such as The Wall Street
Journal and Yahoo! Finance, publish the
public announcement dates of various
economic statistics.
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Figure 17.5 Economic Calendar at
Yahoo!
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Industry Analysis
• It is unusual for a firm in a troubled
industry to perform well.
• Economic performance can vary
widely across industries.
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Figure 17.6 Return on Equity, 2009
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Figure 17.7 Industry Stock Price Performance,
2009
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Defining an Industry
• North American Industry
Classification System, or NAICS
codes
• Firms with the same four-digit NAICS
codes are commonly taken to be in
the same industry.
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Table 17.5 Examples of NAICS Industry Codes
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Sensitivity to the Business Cycle
• Three factors
determine
how sensitive
a firm’s
earnings are
to the
business
cycle.
1. Sensitivity of sales:
• Necessities vs.
discretionary goods
• Items that are not
sensitive to income
levels (such as tobacco
and movies) vs. items
that are, (such as
machine tools, steel,
autos)
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Figure 17.9 Industry Cyclicality
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Sensitivity to the Business Cycle
2. Operating
leverage :
the split
between
fixed and
variable
costs
•
•
Firms with low operating
leverage (less fixed assets)
are less sensitive to
business conditions.
Firms with high operating
leverage (more fixed
assets) are more sensitive
to the business cycle.
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Table 17.6 Operating Leverage of Firms A and B
Throughout the Business Cycle
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Sensitivity to the Business Cycle
3. Financial
leverage:
the use of
borrowing
• Interest is a fixed cost
that increases the
sensitivity of profits to
the business cycle.
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Figure 17.10 A Stylized Depiction of the
Business Cycle
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Sector Rotation
• Portfolio is shifted into industries or
sectors that should outperform,
according to the stage of the business
cycle.
• Peaks – natural resource extraction
firms
• Contraction – defensive industries
such as pharmaceuticals and food
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Sector Rotation
• Trough – capital goods industries
• Expansion – cyclical industries such as
consumer durables
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Figure 17.11 Sector Rotation
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Sector Rotation
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Sector Rotation
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Industry Life Cycles
Stage
• Start-up
• Consolidation
• Maturity
• Relative Decline
Sales Growth
• Rapid and
increasing
• Stable
• Slowing
• Minimal or
negative
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Figure 17.12 The Industry Life
Cycle
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Which Life Cycle Stage is Most
Attractive?
• Quote from Peter Lynch in One Up on Wall
Street:
" Many people prefer to invest in a high-growth
industry, where there’s a lot of sound and
fury. Not me. I prefer to invest in a lowgrowth industry. . . .
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Which Life Cycle Stage is Most
Attractive?
…In a low-growth industry, especially one
that’s boring and upsets people [such as
funeral homes or the oil-drum retrieval
business], there’s no problem with
competition. You don’t have to protect your
flanks from potential rivals . . . and this gives
you the leeway to continue to grow.”
Peter Lynch in One Up on Wall Street
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Industry Structure and Performance:
Five Determinants of Competition
1.
2.
3.
4.
5.
Threat of entry
Rivalry between existing competitors
Pressure from substitute products
Bargaining power of buyers
Bargaining power of suppliers of key
input
→ ↓P → ↓ Profit
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