BM410: Investments Macroeconomic Analysis Or understanding the critical economic factors that affect your company.

BM410: Investments

Macroeconomic

Analysis

Or understanding the critical economic factors that affect your company

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Objectives

A. Do you understand the global analysis framework and the importance of understanding global issues?

B. Do you understand the critical areas of that global analysis framework, particularly economic analysis?

C. Do you understand where to find key international economic data?

D. Do you understand how to include economic data in your company report?

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A. Understand the Global Analysis Framework

I want you to change your thinking• You are not preparing to be a US analyst

• You are preparing to be a global analyst with expertise in the US

Why must you understand global issues?• Your competitors are likely to be global

• They understand global issues• In order to compete, you must understand them as well

For in the future, international business will be just business• Prepare now and you won’t be surprised later

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What is our approach to company analysis?• Fundamental Analysis

• Approach to Fundamental Analysis• Domestic and global economic analysis• Domestic and global industry analysis• Company analysis

• Why use the top-down approach?• The return on a stock is a function of the

market• The return on a market is a function of the

economy• The return on an economy is a function of

the world economy

Global Analysis Framework

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Global Analysis Framework

Global Economic and Political Analysis (what is the world doing?) Country Economic and Political Analysis (what’s happening in my main markets?) Global Industry Analysis (what is the global industry doing?) Country Industry Analysis (what’s happening in my main industry?) Company Analysis (what’s happening with my company?)

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Questions

Any questions on the global analysis framework and why it is important?

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B. Understand Critical Areas of the Global Analysis Framework

Global Economic and Political Analysis (what is the world doing?) Country Economic and Political Analysis (what’s happening in my main markets?) Global Industry Analysis (what is the global industry doing?) Country Industry Analysis (what’s happening in my main industry?) Company Analysis (what’s happening with my company?)

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Global Economicand Political Analysis

Key Considerations Performance in countries and regions is highly variable

• Monitor it well Political risk can change everything

• Keep your hand on the country’s political pulse Exchange rate risk is always there

• Keep abreast and cover yourself if economically feasible, i.e. sales, profits, stock returns

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Country Economic and Political Analysis

Key considerations? 1. Government Policy

• Fiscal and Monetary Policy 2. Factors that impact the economy

• Supply and demand shocks 3. Business cycles

• Troughs and peaks 4. Forecasting

• Tools to help 5. Key variables to watch

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1. Government Policy

Fiscal Policy - government spending/taxing actions as part of “demand-side” management• Direct policy to implement, but hard to decide on

• Therefore difficult to use to fine-tune the economy

• Look at the governments surplus or deficit• This will show the governments spending

program Monetary Policy - manipulation of the money supply

to influence economic activity, also a “demand-side” activity• Easy to formulate, but takes a longer time to work

through the economy

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Government Policy (continued)

Tools of monetary policy• Open-market operations

• Adds/subtracts liquidity to the system• Discount rate

• The ate banks can borrow short-term from the Fed and indirectly the rate consumers pay for borrowing

• Reserve requirements• The amount that banks must keep in cash or on

reserve at the Fed

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2. Factors that Impact the Economy

Demand shocks• Affects the demand for goods and services

• Tax cuts or rebates• Increases in government spending• Dramatic weather changes or political shocks

Supply shock• Affects the supply of good and services

• Commodity price changes• Educational level of economic participants• Technology advances that improve production

or capacity

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3. Business Cycles

How does the economy perform, and how does the industry perform under various economic conditions?• Business Cycle

• Peak• Trough

• Industry relationship to business cycles• Cyclical • Defensive

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4. Forecasting Economic and Industry Performance

Leading Indicators Tend to rise and fall in advance of the economy Examples: Avg. weekly hours of production

workers, stock prices, money supply (M2) Coincident Indicators

Tend to change directly with the economy Examples: industrial production, manufacturing and

trade sales, personal income less transfer payments, Lagging Indicators

Tend to follow or lag economic performance Examples: ratio of trade inventories to sales, ratio

of consumer installment, credit outstanding to personal income, change in index of labor costs

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5. Economic Variables to Watch

Key variables• Gross domestic product• Unemployment rates• Interest rates & inflation• International Trade and Investment

measures• Consumer sentiment

Other variables• Elections, Katrina and Rita, etc.

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Problem

Why do you think the index of consumer expectations is a useful leading indicator of the macro-economy?

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Answer

The index of consumer expectations is a useful leading economic indicator because if consumers are optimistic about the future they will be more willing to spend money, especially on consumer durables, which will increase aggregate demand and stimulate the economy.

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Questions

Do you understand the critical areas of this global analysis framework?

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C. Key sources of international Economic Data?

I. World Bank Global Economic Prospects, published bi-annually World Economic Indicators, published annually

II. Economist Publications Economist magazine, published monthly Economist Intelligent Unit, ongoing publication,

but available for a (very high) fee

III. Wall Street Journal Economic and other forecasts are sporadic, but

available if you watch the table of contents closely

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I. World Bank: Global Economic Prospects

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II. Economist Publications

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Economist Intelligence Unit: Purchased Information

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III. Wall Street Journal

Daily publication• No specific ongoing economic analysis• It does have sporadic forecasts as part of

specific articles and sections• They do have a quarterly economic

forecasts section where various economic forecasts are compared to actual results

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Questions

Any questions on the key sources of international economic information?

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D. Including Economic Forecasts in Financial Analysis

Key issues? What are your forecasts? Where did they come from? How do they come into your forecasts? How do you document them?

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Forecasts Used in this Class

This is not an economic forecasting class• As such, I will give you a recommended forecast• This forecast is on the Apple.xls spreadsheet

• You can copy this directly to your spreadsheet• Note that my forecasts are from the World Bank

• You can, however, change the forecasts consistent with your own views

• All I ask is that you document your changes in views in the ratios section

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Where Economic Data is Used (continued)

Sales Growth• Compare how sales have grown historically within

the economic setting• Has sales growth increased even in difficult

times?

• They may likely continue in the future• Has sales growth declined in difficult times?

• This may also continue in the future

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Where Economic Data is Used (continued)

Forecasting Interest Expense and Interest Income• Generally, most interest rates are (loosely) tied to

LIBOR, the London Inter Bank Offered Rate• Keep your rate on interest income and interest

expense a consistent multiple over or under this rate, i.e. interest income is + 30 bps over LIBOR and interest expense is + 500 bps over LIBOR

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Questions

Any questions on how to include your economic data into your forecasts?

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Review of Objectives

A. Do you understand the global analysis framework and the importance of understanding global issues?B. Do you understand the critical areas of that global framework, particularly economic analysis?C. Can you find sources of data for your international economic prospects?D. Do you know how to write up the industry report?

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D. Understand How to Write Up the Industry Report

Mandatory Framework:• Key Information• Description and Summary• International Competitive Structure• SWOT Analysis/Positives and Negatives

Factors• Key Valuation Ratios• Key Items to Watch

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Key Information

Key Information• Industry Sub-sector• Major Industry• Country• Industry Type

• Use the six types as discussed by Peter Lynch on page 400: Slow Growers, Stalwarts, Fast Growers, Cyclicals, Turnarounds, and Asset Plays

• Key Indices• Include which items are included in the index,

i.e. price, price earnings, dividends, etc.

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Description and Summary

This should include:• A brief description of the industry and what makes

is different. This could include how long it has been around, the key areas of interest, key business models, and any other information that you deem relevant to the discussion.

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International Competitive Structure

This section includes:• The structure of industry suppliers and

competition, i.e., fragmented, oligopolistic; expansion opportunities; the importance of capital, barriers to entry globally, impacts of global regulation and trade, etc.

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Analysis

You can determine the type of analysis• Positive Factors and Negative Factors

• Put these in the order of importance, most important first

• Strengths, Weaknesses, Opportunities, Threats• Clearly delineate which of these are most

important Regardless of your type of analysis, make sure you

cover the industry clearly

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Key Things to Watch

Key Valuation Ratios to Watch• List the key ratios that are followed by analysts in

this industry. • A good start is to look at analysts reports from

Investex Plus in the library (see FR-1A – Finding Key Sources of Financial Information).

Key Items to Watch• These are the key economic and other statistics that

are key to performance for this industry. As you read through your 10-k reports, you will get a strong sense of the key variables to watch.

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Return Performance

This is the relative total return performance versus the market and industry indices (see IR-2A Getting Industry Total Returns)• Include your market index and industry index (note:

your industry index does not need to have PE data to be included here. All it needs is total return data)

• Excess is the difference between the industry return and the market return

GDP Return is the GDP real growth rate for the year from FR-2A Company Financials - AAPL Section 19)• By seeing how the industry and economy has performed

together, it will give you an indication of what might happen in the future