Business cycles and markets Gross Domestic Product (GDP)  Attempt to measure economic activity in a given country during a given year  Y = C + I + G + NX C = consumption I = investment G = government purchases NX = net exports  Usually reported as percent increases, adjusted for inflation

Recent US GDP growth, annualized and inflation-adjusted

Problems with GDP Data collection is difficult Inflation measurement is difficult Government purchases, unlike the other components, are coercively financed and may not reflect people’s perceived welfare GDP is used as a scorecard for the overall economy and an excuse for government economic interventions and manipulations

Recession A recession is generally defined as two consecutive quarters of declining real GDP. A private organization, the National Bureau of Economic Research, issues pronouncements, long delayed, as to when recessions began and ended. The recent “Great Recession” ran from Dec to June The recovery has been very slow

Interest rates Interest rates are a price  Price savers receive for delayed gratification  Price borrowers pay for quicker gratification Interest rates in free markets are set by supply and demand  Savers supply funds on which they wish to earn dividends or interest  Businesses borrow funds (or raise equity capital) to finance projects

Fed manipulation of interest rates The Federal Reserve sets or strongly influences short-term interest rates Since the Great Recession it has also influenced longer- term rates Reduced interest rates send false signals to borrowers that suggest savers are more future-oriented than they really are Businesses focus more attention on long-term projects which are highly interest-sensitive

Boom and bust Eventually the false signals become evident and some long-term projects are abandoned. A recession begins. A recession is not something to be suppressed. It is a cleanup of the preceding false boom. Crowd psychology also plays a role in economic cycles (“booms and busts”)

Stock market cycles

Top down securities analysis Macroeconomic issues that may affect particular industries  Inflation, current and expected  Consumer confidence  Government budget deficits  Trade balances  Prospects of war

Comparing a company with its competitors Product pipeline versus competitors Ease of entry Depth and significance of patent portfolio  Average smart phone affected by 250,000 patents! Financial strength: debt burden, cash holdings Earnings, current and projected