1. Investments and Portfolio Management
WEEK 7 1

2. Market and Industrial Analysis
Objectives :
Understand the importance of macro-economic analysis in the portfolio management process
Carry out market analysis
Carry out industry analysis 2

3. Bottom Up analysis
Based on analysis of company data e.g. P/E ratio or on technical analysis of price patterns for a selected asset.
E.g. merger and acquisition decisions based on forecasting future cash flows of the company (Advanced Corporate Finance) would be considered to be using a Bottom Up approach.
BUT: All companies are affected by general economic conditions to some extent. Similarly, anything affecting the industry, such as the emergence of a substitute industry, will affect all companies within that industry. Therefore, these should be considered. 3

4. Fundamental analysis
This is covered in week 8, but involves the evaluation of internal, company factors to determine whether to invest.
Sometimes fundamental analysts use a bottom up approach e.g. just pick a company and evaluate it.
However, many fundamental analysts recognize that the environment plays an important part and will look at this first to determine which companies to examine fundamentally. 4

5. Top-down approach Analyse aggregate economy and Macroeconomic analysis
E.g. GDP, interest rates
Can use PESTEL analysis or concentrate on specific elements, such as a focused analysis on the financial markets themselves.
Analyse industry factors
To determine which sectors will do well considering economic outlook
Can use Porter’s 5 Forces
Analyse companies within the industry 5

6. Aggregate Economy and Macro-economic analysis
ECST <GO> leads to analysis of all country economic statistics.
Clicking on one of these statistics (e.g. GDP) will show the result by industry sector 6

7. Aggregate Economy and Macro-economic analysis7

8. Rates of Return Annual Equity Returns US$
Country
2010
2009
2008
2007
Iceland
57.2%
10.3%
-96.2%
13.1%
Thailand
56.7%
71.7%
-49.9%
39.0%
Philippines
55.9%
70.4%
-55.5%
36.7%
Chile
49.6%
88.8%
-43.6%
23.0%
United States
15.3%
25.7%
-38.6%
3.8%
United Kingdom
7.0%
39.5%
-51.2% 8
(Source: The Wall Street Journal cited by Reilly and Brown, 2012)

9. 9

10. PESTEL Analysis Step 2 – External analysis Political
Taxation
Foreign Trade regulations
Government Stability
Consumer protection
Social/Demographic
Income distribution
Social mobility
Education levels
Population size
Age distribution
Lifestyle changes
Consumerism
Fashions/tastes
Social issues
Economic
Globalisation
Business cycles
Interest rates
Inflation
Employment levels
Exchange rates
Legal
Monopoly legislation
Environmental legislation
Employment law
Consumer protection
Health & Safety
Technological
Internet / Access to information
Government spending on RnD
New products
New processes/production methods
Rate of Change
Communications
Transport
Ecological
Environmental Protection
Depletion of natural resources
Pollution
Health/Animal Welfare
Disposal of Waste Products 10

11. Economic conditions
Gross Domestic Product (GDP) - the expenditure on final goods and services minus imports
High GDP => new capital investment => higher levels of production => higher GDP…..
i.e. economic growth takes place
Economic decline can occur when level of investment is insufficient to replace depreciated capital.
From an investment perspective, when economies grow so to earnings and the value of financial assets. Demand for funds also increases, causing interest rate rises. 11

12. Fiscal (Govt.) Policy
Fiscal Policy = government spending and taxation policies
Expansionary – increase spending, or decrease taxes
Contractionary – decrease spending or increase taxes
Expansionary => increases demand and therefore increase prices and output (depending on other factors such as employment capacity)
But if debt/GDP increases as a result then growth may be affected. 12

13. Monetary (central bank) Policy
Monetary Policy = central bank policy affecting the supply or cost (interest) of money in the economy
Expansionary – buy govt. bonds, increasing money supply. Interest rate decreases. Capital expenditure increases.
Contractionary – sell govt. bonds, decreasing money supply. Interest rate increases. Capital expenditure decreases.
Foreign sector
Exchange rates
Emerging economies 13

14. Industry analysis Methods: Porter’s Five forces
Threat of New Entrants
Competitive Rivalry
Power of Buyers
Power of Suppliers
Threat of Substitutes
Stages of industrial development (see slide 15)
Supply chains (see slide 16)
Industry valuations (see slide 17) 14

15. Stages of Industrial Development
Pioneering Stage
High development costs
Low sales
Small/negative profits
Rapid accelerating growth stage
Sales grow at increasing rate
Firm expansion
High profit margins
Mature growth stage
Sales grow, usually above economic growth but slower than previously.
Increased competition
Lower profit margins
Stabilisation stage
equilibrium
Deceleration and declining growth stage 15

16. Supply Chains
Leontief (c. 1930) developed a general theory of production based on economic interdependence. Such a relationship can be captured by supply chain models:
Note: this function SPLC <GO> has a non-printable screen. See core text pg. 510 for a better image. 16

17. Industry Valuation
Industry valuation can be carried out in similar ways to company valuation:
E.g. Industry forecast EPS * industry P/E ratio
The industry Sales per share (S) can be used to estimate the profit margin (m) as follows:
m = EPS/SPS
effectively, this is earnings as a percentage of turnover. If the ‘per share’ values cannot be predicted then total industry earnings and sales can be used. 17

18. Summary
A top-down approach analyses markets and industries before selecting assets within them.
There are a variety of models which can be used to help analyse the external environments, in addition to numerous economic ratios. 18

19. Reading Suggested additional reading:
The slides for this week’s lecture have been based on:
Stafford Johnson, R. (2014), Equity Markets and Portfolio Analysis, John Wiley & Sons – Chapter 13
Suggested additional reading:
Read how a student managed equity fund is using a top-down approach for its management:
Stafford Johnson, R. (2014), Equity Markets and Portfolio Analysis, John Wiley & Sons, pp 19

20. Useful Bloomberg Functions
ECONOMIC <GO> produces a menu for a variety of economic analysis functions, including: ECFC <GO> economic forecasts ECST <GO> world economic statistics WIRP <GO> interest rate probabilities TOP ECO <GO> top economic news PMI <GO> 4 <GO> shows data tables for a selected country, including GDP data and analysis of different industries 20

21. Useful Bloomberg Functions
COUN <GO> and ‘economics’ tab, provide an overview of the economy of a country of choice
Real GDP chart
Economic forecasts
Economic calendar
Economic News
Central Bank 21

22. Useful Bloomberg Functions
GDP <GO> shows world GDP statistics WEI <GO> looks at world economic indices. If you have determined the country and industry of choice, you can click on the name of an appropriate country index, which then provides a list of securities by sector, thus allowing you to select an appropriate security. RV <GO> shows relative analysis of firms within an industry Select a ticker, using SECF <GO>if necessary, and then type BI INDUSTRY <GO>. This provides industry news and intelligence for the industry within which that asset operates. Can also type BI <GO>, select ‘sector’, select ‘industry’, select ‘comp sheets’ 22