Macroeconomic and Industry Analysis

Bodie, Kane and MarcusEssentials of Investments 9th Global Edition

12

12.1 GLOBAL ECONOMY• National Economic Environment

• Crucial determinant of industry performance

• Exchange Rate• Rate at which domestic currency can be converted into foreign currency

TABLE 12.1 ECONOMIC PERFORMANCE

2011 Stock Market Return (%)

In Local Currency In U.S. Dollars Forecasted Growth in GDP, 2012 (%)

Brazil -22.9 -28.9 3.5

Britain -3.9 -4.2 0.2

Canada -9.1 -10.9 2.0

China -22.7 -19.1 8.2

France -16.1 -19.2 -0.3

Germany -11.6 -14.9 0.1

Greece -53.2 -54.9 -7.5

India -22.6 -34.6 7.8

Italy -24.0 -26.9 -1.1

Japan -16.3 -11.6 1.7

Mexico -3.0 -12.9 3.1

Russia -15.4 -19.0 3.7

Singapore -15.0 -15.5 4.0

South Korea -9.0 -10.1 3.8

Thailand 0.3 -3.9 3.1

U.S. 1.6 1.6 2.0

Source: The Economist, January 7, 2012

FIGURE 12.1 CHANGE IN REAL EXCHANGE RATE

Canada

Japan

Euro

U.K.

-35% -30% -25% -20% -15% -10% -5% 0% 5% 10%

-28.9%

2.7%

-13.4%

4.3%

U.S. dollar versus major currencies, 1999-2010

FIGURE 12.2 S&P 500 INDEX VERSUS EARNINGS PER SHARE

19

55

19

59

19

63

19

67

19

71

19

75

19

79

19

83

19

87

19

91

19

95

19

99

20

03

20

07

20

11

0

500

1000

1500

2000

2500

S&P 500 EPS x 12

EPS x 18 EPS x 25

12.2 THE DOMESTIC MACROECONOMY

Gross Domestic Product (GDP) Market value of goods and services produced over

period of time Unemployment Rate

Ratio of number of unemployed to total labor force Inflation

Rate at which general level of prices for goods and services is rising

12.2 THE DOMESTIC MACROECONOMY

Interest Rates High interest rates reduce present value of future cash

flows Budget Deficit

Government spending in excess of government revenues

Sentiment Consumer optimism/pessimism are determinants of

economic performance

12.3 INTEREST RATES Fundamental Factors of Interest Rates

Supply of funds from savers Demand for funds from borrowers Government’s net supply/demand for funds, modified

by Federal Reserve Expected rate of inflation

FIGURE 12.3 DETERMINATION OF EQUILIBRIUM REAL RATE OF INTEREST

12.4 DEMAND AND SUPPLY SHOCKS Demand Shock

Event that affects demand for goods and services in economy

Supply Shock Event that influences production capacity and costs in

economy

12.4 DEMAND AND SUPPLY SHOCKS

The price of imported oil fell dramatically in late 2008. What sort of macroeconomic

shock would this be considered?

12.5 GOVERNMENT POLICY Fiscal Policy

Use of government spending and taxing for stabilizing economy

Monetary Policy Actions taken by the central bank to influence money

supply or interest rates Supply-Side Policies

Address productive capacity of economy, goal is to induce workers/owners to produce goods

12.6 BUSINESS CYCLES Business Cycles

Recurring cycles of recession and recovery Peak

Transition from end of expansion to start of contraction Trough

Transition point between recession and recovery

12.6 BUSINESS CYCLES Cyclical Industries

Industries with above-average sensitivity to state of economy

Defensive Industries Industries with below-average sensitivity to state of

economy

FIGURE 12.4 CYCLICAL INDICATORS

FIGURE 12.4 CYCLICAL INDICATORS

12.6 BUSINESS CYCLES Leading Economic Indicators

Economic series that tend to rise or fall in advance of rest of economy

Stock-market-price indexMoney supplyManufacturers’ orders

TABLE 12.2 INDEXES OF ECONOMIC INDICATORS

FIGURE 12.5 INDEXES OF LEADING, COINCIDENT, AND LAGGING FACTORS

12.7 INDUSTRY ANALYSIS Defining an Industry

NAICS codes in the US

Classification of firms into industry groups using numerical codes to identify industries

KSE sectors

FIGURE 12.7 RETURN ON EQUITY, 2011

Money center banksHeavy construction

Electric utilitiesAuto manufacturers

TruckingBiotech

Food productsAsset managementBusiness software

Telecom servicesHome improvement

PharmaceuticalsAerospace/defense

Health care plansIntegrated oil & gas

Chemical productsIndustrial metals

Application softwareRestaurants

Computer systems

0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0

6.77.07.1

7.98.58.79.0

10.311.4

14.115.615.8

17.117.2

18.119.6

24.624.9

29.636.4

FIGURE 12.7 RETURN ON EQUITY, KSE

FIGURE 12.8 INDUSTRY STOCK PRICE PERFORMANCE, 2011

Money center banks

Heavy construction

Electric utilities

Auto manufacturers

Trucking

Biotech

Food products

Asset management

Business software

Telecom services

Home improvement

Pharmaceuticals

Aerospace/defense

Health care plans

Integrated oil & gas

Chemical products

Industrial metals

Application software

Restaurants

Computer systems

-40.0 -30.0 -20.0 -10.0 0.0 10.0 20.0 30.0

-25.3

-17.1

13.1

-33.2

-7.7

5.5

11.3

-20.1

-8.6

-9.1

12.9

14.7

5.5

10.5

13.4

-4.6

-21.2

-8.6

27.8

16.3

Rate of return (%)

FIGURE 12.8 INDUSTRY STOCK PRICE PERFORMANCE, 2011

KSE

Oil & Gas

Basic Materials

Industrials

Consumer Goods

Health Care

Consumer Services

Telecommunications

Banks

Insurance

Real Estate

Financial Services

Technology

Parallel

-30 -20 -10 0 10 20 30

Sector Return % 2012

FIGURE 12.9 ROE OF APPLICATION SOFTWARE FIRMS

Microsoft

SAP

Intuit

Oracle

CA (Computer Assoc)

Adobe

0 5 10 15 20 25 30 35 40 45 50

44.2

26.0

25.7

24.3

15.5

15.2

ROE (%)

TABLE 12.5 EXAMPLES OF NAICS INDUSTRY CODES

FIGURE 12.10 INDUSTRY CYCLICALITY1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

-15%

-10%

-5%

0%

5%

10%

15%Grocery

Jewelry

An

nu

al

sa

les g

row

th (

%)

12.7 INDUSTRY ANALYSIS Sensitivity to the Business Cycle

Sensitivity of salesNecessary product or luxury?Low sensitivity to income

Operating leverageFinancial leverage

12.7 INDUSTRY ANALYSIS

FIGURE 12.11 STYLIZED DEPICTION OF BUSINESS CYCLE

12.7 INDUSTRY ANALYSIS Sector Rotation

Shifting portfolio into industry sectors expected to outperform others based on macroeconomic forecastsNear peak, invest in natural resource extraction and processing firms

After peak, defensive industries often better performers

In trough, capital goods industries often better performers

In expansion, cyclical industries often better

FIGURE 12.12 SECTOR ROTATION

12.7 INDUSTRY ANALYSIS

12.7 INDUSTRY ANALYSIS Industry Life Cycles: Stages Firms Pass Through to

Maturity Start-up stage: Often characterized by new

technology/product Consolidation stage: Industry leaders begin to emerge Maturity stage: Product has reached potential for use

by consumers Relative decline: May grow less than rest of economy

or shrink

FIGURE 12.13 INDUSTRY LIFE CYCLE

FIGURE 12.13 INDUSTRY LIFE CYCLE

At what stage in the life cycle of an industry is investment most

attractive and lucrative?

PETER LYNCH’S INDUSTRY CLASSIFICATION

Stage Characteristic

Slow Growers Cash cow

Stalwarts Cash cows with a bit higher growth (e.g. Coca-Cola)

Fast Growers High growth rates

Cyclicals Moves with the economy

Turnarounds In bankruptcy or heading to it and can reover

Asset Play Valuable assets not reflect in the stock price

12.7 INDUSTRY ANALYSIS Industry Structure and Performance

Threat of entry: New entrants to industry pressure price/profits

Rivalry between existing competitors: Market share competition pressures price/profits

Pressure from substitute products: Firms in related industries can threaten market share

12.7 INDUSTRY ANALYSIS Industry Structure and Performance

Bargaining power of buyers

Large-scale buyers have considerable bargaining power

Bargaining power of suppliers

Large-scale suppliers have considerable bargaining power

MY PROBLEMS

Basic4 effect of policy on business conditions (1)

Intermediate (6 problems)17 industry sensitivity (3)19 industry sensitivity (3)21 industry life cycle (4)24 effect of policy on business conditions (1)

CFA Problems (2 problems)2 industry life cycle (4)4 industry life cycle (4)

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