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Chapter 12 - Macroeconomic and Industry Analysis
CHAPTER TWELVE
MACROECONOMIC AND INDUSTRY ANALYSIS
CHAPTER OVERVIEW
others and should have a rudimentary knowledge of the characteristics of an industry that affect
competitiveness.
CHAPTER OUTLINE
The top-down approach to fundamental analysis begins with analyzing the economy. Expected
1. The Global Economy
PPT 12-2 through PPT 12-4
12-1
economists expect an L shaped recovery rather than the more typical V shaped recoveries we
have had from the previous mild recessions of the 90s and the early 2000s. Third, notice that
stock market returns were terrible even though the countries had positive GDP growth. In some
cases, countries with higher growth rates had poorer stock returns. As always what matters is the
2. The Domestic Macroeconomy
PPT 12-5 through PPT 12-7
This section will present some of the key economic statistics used to describe the state of the
macroeconomy. Key economic variables used in assessing the economy include gross domestic
2008. A drop in consumer confidence does not bode well for the economy since about 75% to
80% of growth in GDP has been driven by growth in consumer spending in recent years. Export
growth is unlikely to make up the slack if consumers rein in capital spending for any extended
period of time. Savings rates have increased sharply as well.
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3. Interest Rates
PPT 12-8 through PPT 12-9
Forecasting interest rates is one of the most difficult areas of applied macroeconomics and yet is
perhaps the most important to consider in analyzing investments. A very simple supply-and-
4. Demand and Supply Shocks
PPT 12-10
Analysis of the economy will often distinguish between demand and supply shocks. A demand
shock is an event that affects demand for goods and services. A tax cut is a policy action designed
hurt. For example, choose consumer cyclicals if the economy is projected to do well, but not if
the economy will weaken, one may choose more defensive investments such as consumer staples
utilities if the economy is not expected to do well. To earn abnormal returns investors must have
better information (unlikely) or better analysis than the competition. Consumer cyclicals include
5. Federal Government Policy
PPT 12-11
Fiscal policy involves government spending and taxing actions. Fiscal policy is an attempt to
influence the economy in a direct fashion. Monetary policy involves manipulation of the money
2008. Evidence shows that severe recessions result in governments having to borrow more than
the amount needed for a temporary fiscal stimulus. Whether the actual stimulus bill Congress
passed was a good bill or not is another question. Many students will not understand this issue
and it is worth explaining. Fiscal policy is generally a poor means to fine tune an economy, and, if
misused, it can be inflationary. Fiscal policy probably was needed in the crisis due to the inability
inflationary periods of the 1970s the Fed increased the money supply and interest rates fell, but
quickly began to rise again due to inflationary expectations in the economy. For this reason the
Fed tries to keep inflation out of the system.
12-4
dealers. To pay for the purchase the Fed ‘hits a computer button’ and creates more deposits on
reserve at the Fed for the seller. This is the main way that the money supply is expanded, rather
than ‘printing money’ as people often euphemistically say.
Monetary policy is an attempt to change the incentives to purchase and invest, but changing the
money supply and interest rates still may not lead to the desired effect on demand. Japan went
Together these should generate faster economic growth and “lift all boats,” so to speak.
However, we probably cannot rely solely on supply-side policies in a severe recession such as the
Financial Crisis of 2008. With the debt overhang (high levels of indebtedness) these policies are
unlikely to be sufficiently effective on their own. Income inequality may also rise as a result of
supply side policies. Those with better ideas, education, opportunities, work ethic, providence,
trade all can lead to higher wealth, but greater inequalities.
6. Business Cycles
PPT 12-12 through PPT 12-20
A business cycle refers to periods of expansion and contraction. A peak is the high point
following a period of economic expansion. A trough is the low point following a period of
Chapter 12 - Macroeconomic and Industry Analysis
7. Industry Analysis
PPT 12-21 through PPT 12-33
Industry analysis is used to identify industries that are expected to perform well in the future. The
variability of return on equity, and industry stock-price performance are displayed in the PPT.
Note that performance can vary widely among industries. It can be difficult to find a high-
another? Many industries are closely related. The North American Industry Classification System
or NAICS has developed a useful way to define industry groups.
Some industries, such as capital goods are very sensitive to economic performance. The sale of
capital goods is heavily influenced by the performance of the economy. Manufacturers do not
purchase capital goods for expansion if the economy is not expected to perform well. In addition
swings in profits over the business cycle. Examples of industries with high amount of operating
leverage include airlines and automobiles. Financial leverage is the proportion of fixed financing
costs as a percent of total costs. Greater financial leverage results in greater swings in profits over
the business cycle. Examples of industries that employ a high degree of financial leverage include
airlines, banks and investment banks. Industries have their own life cycles that will impact their
we are in until later and the duration of each phase is also unknown.
The common stages of industry life cycles and the accompanying pattern of sales growth are
presented in the PPT. Start up industries experience rapid growth in sales. Maturing industries
experience slowing growth in sales. Industries in relative decline commonly experience declining
sales. Stages:
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Chapter 12 - Macroeconomic and Industry Analysis
Maturity stage example: Product has reached saturation level (think McDonald’s or perhaps basic
cell phones today), generally more competition and less diversification, so price competition
growth must slow. Utilities are in the mature phase and have lower rates of investment and lower
rates of return on investment and higher dividends.
The last section of the chapter looks at Michael Porter’s five determinants of competition: threat
of entry from new competitors, rivalry between existing competitors, price pressure from
substitute products, the bargaining power of buyers, and the bargaining power of suppliers. The
1. Threat of Entry
New entrants reduce profitability
Barriers to entry preserve profitability, examples of barriers include
2. Rivalry between existing competitors
a. Equal competitors reduce profitability
3. Pressure from substitute products
Substitutes limit profitability (propane, natural gas)
4. Bargaining power of buyers
5. Bargaining power of suppliers
A supplier that controls a key input can limit the buying industry’s profitability (labor
