Type
Solution Manual
Book Title
Fundamentals of Investments: Valuation and Management 8th Edition
ISBN 13
978-1259720697

978-1259720697 Chapter 19 Lecture Note

January 2, 2020
Chapter 19
Global Economic Activity and Industry
Analysis
Slides
19.1. Chapter 19
19.2. Global Economic Activity and Industry Analysis
19.3. Learning Objectives
19.4. Global Economic Activity and Industry Analysis
19.5. Top Down Analysis, I.
19.6. Top Down Analysis, II.
19.7. Global Macroeconomic Activity, I.
19.8. Global Macroeconomic Activity, II.
19.9. GDP versus Market Capitalization (15 leading economies in the world, as of
mid-2015)
19.10. Business Cycles
19.11. Phases of the Business Cycle
19.12. U.S. Real GDP (where’s the cycle?)
19.13. U.S. Real GDP Growth (The Cycle is in GDP Growth)
19.14. Making Cyclical and Defensive Investment Decisions: Where will the
Business Cycle go?
19.15. Economic Indicators, I.
19.16. Leading, Coincident, and Lagging Economic Indicators
19.17. Economic Indicators, II.
19.18. The Effects of Exchange Rates on Global Investments, I.
19.19. The Effects of Exchange Rates on Global Investments, II.
19.20. The Effects of Exchange Rates on Global Investments, III.
19.21. Labor Market Indicators
19.22. The Consumer Price Index, I.
19.23. The Consumer Price Index, II.
19.24. U.S. Real GDP Growth and CPI
19.25. The Consumer Price Index, III.
19.26. Monetary Policy
19.27. U.S. M2 and S&P 500 Index
19.28. The Federal Reserve: The Central Bank of the United States
19.29. Money Creation, I.
19.30. Money Creation, II.
19.31. Fiscal Policy, I.
19.32. Fiscal Policy, II.
19.33. Country Debt, 2010
19.34. Industry Analysis, Overview
19.35. There are Many Ways to Define a Sector
19.36. Ten Sectors of S&P, Late 2015
19.37. Rotational Investing, I.
19.38. Rotational Investing, II.
19.39. S&P 500 Sector Returns (as of November 6, 2015)
19.40. S&P 500 Heat Map
19.41. S&P 500 Heat Map
19.42. Subsector (Industry) Differences, I
19.43. Subsector (Industry) Differences, II.
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Global Economic Activity and Industry Analysis 19-2
19.44. The Industry Life Cycle
19.45. The Industry Life Cycle
19.46. Porters Five Forces
19.47. Porters Five Forces Model of Competition
19.48. Porters Five Forces: Details.
19.49. Useful Internet Sites
19.50. Chapter Review, I.
19.51. Chapter Review, II.
Chapter Organization
19.1 Top-Down Analysis
19.2 Global Macroeconomic Activity
A. Real GDP
B. Business Cycles
C. Economic Indicators
D. The Global Economy and Stock Return Correlations
E. The Effects of Exchange Rates on Global Investments
19.3 Monitoring Jobs and the Price Level
A. Labor Market Indicators
B. The Consumer Price Index
19.4 Monetary and Fiscal Policy
A. Monetary Policy
B. Fiscal Policy
19.5 Industry Analysis
A. Identifying Sectors
B. Porters Five Forces
19.6 Summary and Conclusions
Selected Web Sites
www.economist.com (information on current economic statistics)
www.xe.com (information on exchange rates)
www.usdebtclock.org (running clock of US debt)
finviz.com/map.ashx (market “heat map” shows sector performance)
www.msci.com/gics (find GICS classifications)
www.morningstar.com/InvGlossary/economic_moat.aspx (information on
industry power ratings, or “economic moat”)
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McGraw-Hill
Education.
Global Economic Activity and Industry Analysis 19-3
Annotated Chapter Outline
19.1 Top-Down Analysis
The two basic approaches to security selection are “bottoms-up” and “top-down.”
A bottoms-up approach identifies individual companies without regard for industry
or global economic issues. A top-down approach acts as a filter, beginning with a
large set of possible securities and narrowing down based on global or industry
trends.
19.2 Global Macroeconomic Activity
A. Real GDP
Gross Domestic Product (GDP) is the market value of goods and
services produced over a period of time.
Real GDP is the value of economic output adjusted for price changes, i.e.,
inflation.
GDP is positively correlated to the market value of country stock markets. Thus,
changes in GDP (particularly real GDP) may be a positive indicator of future
market performance.
B. Business Cycles
A typical business cycle includes: peak, contraction, trough, and expansion.
While overall GDP may not be highly cyclical (figure 19.4a), the growth in GDP is
quite volatile (Figure 19.4b) and often follows this general pattern.
Cyclical Industries: have a high sensitivity to the business cycle.
Defensive Industries: have a low sensitivity to the business cycle.
C. Economic Indicators
Given the importance of GDP, being able to forecast changes is important.
Leading economic indicators tend to rise or fall in advance of the economy and
thus provide a potential gauge for estimating these changes.
Leading economic indicators are an economic series that tend to rise or
fall in advance of the economy.
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Education.
Global Economic Activity and Industry Analysis 19-4
Table 19.1 provides a list of these indicators.
D. The Global Economy and Stock Return Correlations
Diversification across countries is generally beneficial, but increased integration
has reduced some of the benefits. Particularly in bear markets (such as 2008),
correlations tend to go to +1.
E. The Effects of Exchange Rates on Global Investments
One of the most important elements of international investing is the exchange
rate. The total return on an international investment is driven by two elements:
the investment itself and changes in the exchange rate. A positive investment
may net a negative return if the exchange rate moves counter to the investment.
As an investor, we would like to be invested in currencies that are appreciating in
value. For example, consider the following:
You invest $100,000 in an Australian equity at a beginning exchange rate
of 0.80A$ / $. Your investment earns 10%, and the ending exchange rate
is 0.85A$ / $. What is the total return?
Well, the A$ depreciated relative to the US $, thus your total return will be
below 10%. In extreme cases, the total return could even be negative
even if the investment itself earned a positive return.
Step 1: $100,000 (0.80) = 80,000A$
Step 2: 80,000 (1.1) = 88,000 A$
Step 3: 88,000 / (0.85) = $103,529.41
Step 4: ($103,529.41 / $100,000) – 1 = 3.53% total return
19.3 Monitoring Jobs and the Price Level
A. Labor Market Indicators
About 70% of GDP is driven by consumers. Thus, employment (or, conversely,
unemployment) is a critical element for gauging overall economic health.
Unemployment rate = percentage of the labor force (not total population)
that is unemployed.
Labor force = all nonmilitary people who are officially employed or
unemployed.
Labor force participation rate = labor force divided by working age
population.
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Education.
Global Economic Activity and Industry Analysis 19-5
Changes in unemployment are important, but beware that this may occur for
reasons other than actual jobs. For example, the participation rate may decline if
potential workers become discouraged and simply drop out of the labor force.
B. The Consumer Price Index
The Consumer Price Index (CPI) measures the average price level of a
basket of goods and services.
Changes in the price level reflect inflation. For example, if the CPI moves from
100 to 102, this is an inflation rate of 2%. High inflation is inversely related to real
economic growth. The “goldilocks” scenario is: high income growth, low
unemployment, and low inflation. Countries with such characteristics may
represent good investments.
19.4 Monetary and Fiscal Policy
A. Monetary Policy
Monetary policy is the responsibility of the Federal Reserve (Fed), who attempts
to control the overall money supply. The goals are to control inflation, generate
full employment, moderate the business cycle, and help achieve long-term
growth.
To achieve these goals the Fed relies on changing interest rates, particularly the
discount rate, as well as conducting open market operations.
Open market operations: the buying and selling of bonds directly on the
secondary market for purposes of increasing or decreasing the money
supply.
Any infusion of money will likely have a larger impact on the money supply due to
the fractional reserve banking system. If the reserve requirement (percent of
deposits retained by banks) is 20%, the associated multiplier is 5 (= 1 / .2),
indicating an infusion of $100 million has a potential impact of $500 million.
An increase in the money supply that is too much for the economy will generate
inflation.
B. Fiscal Policy
Fiscal policy: government determination of tax rates and spending
policies.
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Global Economic Activity and Industry Analysis 19-6
Supply-side economists believe lower tax rates actually increase tax revenues
since it spurs economic growth. In contrast, an increase in government debt may
crowd out private investment and reduce growth.
19.5 Industry Analysis
A. Identifying Sectors
How should we define an industry (or sector)? The S&P 500 is broken into 10
basic sectors. (See Table 19.3 for a breakdown.) Investors may undertake
“rotational investing,” in which they rotate their investments from one sector to
another.
It is important to note that not all sectors perform in line with the overall market.
Some may be negative, even if the overall market appears favorable.
But, all firms within a sector may not be comparable. For example, Disney and
Ford are both in consumer discretionary. To get more specific, S&P also has the
Global Industry Classification Systems (GICS) that further categorizes into 147
sub-industries.
B. Porters Five Forces
A particularly useful tool for analyzing industries is Porter’s Five Forces, which
includes:
Threat of new entrants
Bargaining power of suppliers
Bargaining power of buyers
Threat of substitute products
Intensity of rivalry
Understanding these issues may help the analyst/investor determine whether
earnings are sustainable and how much growth is possible.
19.6 Summary and Conclusion
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