12 Macroeconomic and Industry Analysis Bodie, Kane and Marcus Essentials of Investments 9th Global Edition

National Economic Environment Exchange Rate 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 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 U.S. 1.6 Source: The Economist, January 7, 2012

Figure 12.1 Change in Real Exchange Rate

Figure 12.2 S&P 500 Index versus Earnings per Share

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 Monetary 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 Peak Trough 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 Defensive 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 Stock-market-price index Money supply Leading Economic Indicators Economic series that tend to rise or fall in advance of rest of economy Stock-market-price index Money supply Manufacturers’ 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

Figure 12.7 Return on Equity, KSE

Figure 12.8 Industry Stock Price Performance, 2011

Figure 12.8 Industry Stock Price Performance, 2011

Figure 12.9 ROE of Application Software Firms

Table 12.5 Examples of NAICS Industry Codes

Figure 12.10 Industry Cyclicality

12.7 Industry Analysis Sensitivity of sales Operating leverage Sensitivity to the Business Cycle Sensitivity of sales Necessary product or luxury? Low sensitivity to income Operating leverage Financial 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 forecasts Near 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 Basic Intermediate (6 problems) CFA Problems (2 problems) 4 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) Webmaster 1