Chapter 12
Macroeconomic and Industry Analysis
12.1 The Global Economy
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The Global Economy
•
Fundamental Analysis
-
Analysis of the determinants of firm value,
specifically attempting to forecast the earnings
and dividends of a firm.
- Top down approach:
Analyze economy
Analyze industry
Analyze firm
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•
Performance in countries and regions is highly variable
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•
Politics affects the economy
EX) The biggest international economic story in late 1997 and
1998 was the turmoil in several Asian economies.
- Highlighted the close interplay between politics and
economics.
- Affect trade policy, the free flow of capital, and the status of a
nation’s workforce.
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•

Foreign exchange rates affect the international competitiveness of a country’s industries.
-How are the following affected by a change in the value of the
dollar?
EX) Yen profit on sale of Toyota cars in U.S.
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12.2 The Domestic Macroeconomy
12-8
•
Gross domestic product
-
The market value of gods and services produced
domestically in a given time period
-
Growing GDP indicates an expanding economy, providing a firm with an opportunity to increa
se sales.
•
Unemployment rate
-

The ratio of number of people classified as unemployed to the total labor force.
-
Measures the extent to which the economy is operating at
full capacity.
•
Inflation
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The rate of change in the general price level as measured by some price index such as Con
sumer Price Index or Producer Price Index.
-
High rate of inflation are associated with overheated economies where the demand for good
s and services is outstripping productive capacity.
Key Economic Variables
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Key Economic Variables
•
Interest Rates
-
High interest rates reduce the present value of future cash flow, thereby reducing the attractiveness of
investment opportunities.
-
Major impact on security prices (stocks and bonds) and the level of economic growth
•
Budget Deficits
-
The budget deficit is the amount by which government spending exceeds government revenues.
-
Budget deficits must be offset by government borrowing.

-
Large amounts of government borrowing can force up interest rates by increasing the total demand for
credit in the economy.  Excessive government borrowing will crowd out private borrowing and investin
g.
•
Alternative to crowding out is overreliance on foreign borrowing.
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Key Economic Variables
•
Sentiment

- Consumers’ and Producers’ optimism or pessimism concerning the economy
and job prospects.
- If consumers have confidence in their future income levels, they will be more
willing to spend on big-ticket items.
- If firms predict higher demand for their products, businesses will increase
production and inventory levels.
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12.3 Interest Rates
•
The level of interest rates affect both credit and stock market.
- If the expectation is that rates will increase by more
than the consensus view, you will want to avoid
longer term fixed-income securities.
- Unpredicted increases in rates are associated with
stock market declines.
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Factors Determining the Level of Interest Rates
1.
Supply of funds from savers

2.
Demand for funds from businesses
3.
Government’s net supply and/or demand for funds
•
Fiscal policy
•
Monetary policy
4.
Expected rate of inflation
•
Interest rates contain a premium for expected inflation
•
The Federal Reserve typically raises interest rates proactively when inflation is expect
ed to increase
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Second level
Third level
Fourth level
Fifth level
Figure 12.3 Determination of the Equilibrium
Real Rate of Interest
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Households Saving
Firm’s Demand
Budget De&cit
·
11
Increase in Money Supply

The higher the real interest rate,
the greater the supply of household savings.
The lower the real interest rate,
the greater the loanable fund demand of &rm.
12.4 Demand and Supply Shocks
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Demand Shocks
-
An event that affects the demand for goods and services, some examples include:
•
Change in tax rates
•
Change in the money supply
•
Change in government spending
•
Change in foreign export demand
-
Positive demand shocks  Increase interest rate
 Increase inflation rate
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Supply Shocks
-
An event that influences production capacity and
input costs, including labor costs, examples
include
•
Changes in the price or availability of imported oil
•
Freezes, Floods, or Droughts

•
Changes in the educational level of an economy’s workforce
•
Changes in wage rates
-
Negative supply shocks tend to result in demand > supply, which is inflationary. Negative supply shocks
also may result in reduced output, leading to slower economic growth.
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Tie to investments
Choose industries that will be helped by your expected economic scenario and avoid those that will be hurt.
•
For example, choose consumer cyclical if the economy is projected to do well, but not if the economy will wea
ken,
•
May choose consumer staples and necessities such as utilities if the economy is not expected to do well.
To earn abnormal returns, you must have better information (unlikely) or better analysis than the competition.
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12.5 Federal Government Policy
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Fiscal Policy
•
Government spending and taxing actions to stabilize or spur growth in the economy (demand-side m
anagement)
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Most direct policy method in terms of its effect on the economy (Keynesian policy).
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Often implemented too slowly due to political process.
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Much of government spending such as Medicare or Social Security is determined by formula rather than policy and
cannot be changed in response to economic conditions.

-
May be necessary when monetary policy is ineffective such as
in the Financial Crisis of 2008.
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Monetary Policy
•
Manipulation of the money supply to influence economic activity by influencing the demand for goods and s
ervices to be produced and consumed
- Works largely through its impact on interest rates.
: Increase in the money supply  lower short-term interest rates  encourage invest and consumption de
mand.
: However, over longer periods, a higher money supply  a higher price level
-
Stimulation/inflation trade-off
-
Easily formulated and implemented but has a less immediate impact.
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•
Tools of monetary policy

Open market operations
- Buy or sell Treasury bonds

Discount rate, which is the interest rate it charges banks on short-term loans. Decrease in discount rate  Expansionary m
onetary policy.

Reserve requirements, which is the fraction of deposits that banks must hold as cash on hand or as deposits with the Fed.
Lowering reserve requirement  Stimulate the economy.


Federal fund rate, which is the interest rate at which banks make short-term, usually overnight, loans to each other.
- Unlike the discount rate, the fed funds rate is a market rate.
- But, FRB targets the fed funds rate.
Monetary Policy
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Supply-Side Policies
•
Supply-side policies treat the issue of the productive capacity of the economy.
•
Purposed for creating an environment in which workers and owners of capital have the maximum incentive and ability
to produce and develop goods.
•
Supply-siders focus on incentives and marginal tax rates.
•
Lowering tax rates tends to
- Encourage more investment
- Improve incentives to work
- Generate faster economic growth
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12.6 Business Cycles
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The Business Cycle
•
Recurring patterns of recession and recovery
- Peak: the transition from the end of an expansion to the start of a contraction
- Trough: Occurs at the bottom of a recession just as the economy enters a recovery.
•
Industry relationship to business cycles

- Cyclical industries

Industries with above average sensitivity to the state of the economy

EX) Producers of durable goods such as automobiles.
- Defensive

Industries with below average sensitivity to the state of the economy

EX) Food producers and pharmaceutical firms
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