Chapter 17: Macroeconomic and Industry Analysis Flashcards
What is the difference between Passive, Structured, and Active Portfolio Management
Passive managers believe markets are efficient and securities are fairly priced. Aim to replicate the performance of the market but NOT outperform it!
- Main goal: is to align their clients’ portfolios with the right asset allocation and match the returns of broad indexes, like the TSX or bond indexes.
- By following an index, they can offer broad diversification and lower costs since there’s less trading and research involved.
- Their performance is evaluated by how closely their returns match the benchmark (ex. S&P 500), with tracking error used to measure any deviation.
Structured managers think markets are mostly efficient but seek to capitalize on inefficiencies in certain sectors or times.
- They match a benchmark (ex. S&P 500) with most of the portfolio and aim for alpha (excess return) with a smaller portion.
Active managers believe there are market inefficiencies they can exploit to earn excess returns (alpha) and charge higher fees for this.
- will want to outperform their benchmark (ex. market index) and may invest in growth stocks
Define Fundamental Analysis and what are the 4 factors?
Fundamental Analysis: says that a frim’s value is based on the Present Value (PV) of its future cash flows/earnings
4 Factors influence these earnings:
- Global Economy: Earnings are affected by global events, such as the impact of the pandemic.
- Domestic Macro-Economy: Economic conditions within a country, like easing lockdown restrictions, can lead to faster stock price increases in some regions (e.g., the USA vs. the UK).
- Industry Factors: A firm’s performance is also influenced by conditions within its specific industry.
- Firm-Specific Factors: Individual companies may perform differently even within the same sector; for example, while many pharmaceutical stocks are rising, only a few may succeed in developing a COVID vaccine or treatment.
Top-Down Management Approach: what are the components and explain what the manager does with this.
At least memorize two from each one
- Global Factors: Macroeconomic and Political Outlook
- Country-Specific: Socio Political Developments, Real economy, Monetary and Fiscal Policies
- Sector Specific: Growth trends, relative valuations, understanding cycles
- Stock Selction: Quantitative and Qualitative factors
- Managers typically spend most of their time looking at the “top” aka Global and domestic macro factors before picking their stock
Global Macro Analysis talks about where to invest globally, but what are some factors to consider?
- Political Risk - changes in gov, trade conflicts (ex. Russia tariffs)
- Foreign exchange rate risk - British pound relative to the USD
- and overall, Global Growth outlook
The Domestic Macro-Economy, makes you think about what asset classes (in a country) you want to overweight and underweight in your porfolio. What factors should you consider?
Example for overweight and underweight: If we normally hold a 60/40 portfolio (60% equities and 40% bonds) and if we believe that the Canadian economy is going to rebound quickly in early 2021, then we might overweight equities (Perhaps bring them as high as 70 or 80%) and underweight bonds (bring them down to 20 -30%). Because stocks perform better in a strong economy where cash is flowing
Factors to consider:
1. Current **equity vaulation levels **
2. Fiscal Policy
3. Monetray Policy — prediction for future interest rates and money supply (IMPORTANT)
4. Economic Indiators — Leading, Coincident, and Lagging
5. Business Cycles
What are the key measures of health in an economy?
- GDP
- Unemployment
- Inflation
- Interest rates
- Budget Deficit
- Consumer and Business Sentiment
What is the difference between a Demand vs Supply Shock
Demand Shock: is an event that affcets demand for goods and services in the economy
- ex. COVID-19 caused a large demand of toilet paper
Supply Shock: an event that influences productio capacity or production costs
- ex. natural disaster, agricultural droughts
what is Fiscal policy and Monetray Policy
Fiscal Policy: the governet’s spending and taxing actions
* directive way to stimulate or slow the economy
Monetary Policy: manipulation of the money supply
Tools:
* open market operations (OMO, Open Money OUT / Open Money ON): the buying gov securities from (to increase money flow in banking system) and selling governmnet securities to banks (gaining money from banks),
* in attenmpt to increase and decrease money supply in the economy
* money goes out of the economy by selling securities
* money turns on by buying securities from banks
- discount rate
- reserve requirements — portion of the bank’s deposits that are not lent out (depending on their liabilities)
What are the three Economic Indicators?
Leading indicators: happens before, tend to rise and fall advance of the economy
Such as
* average work week
* new orders for durables (last long, used repeatedly, ex. cars)
* **Real money supply (most leading!) **- includes all cash in circulation and all bank deposits that the account holder can easily convert to cash.
* stock market
Coincident indicators: tend to change with the economy (at the same time)
* industrial production, trade sales
Lagging indicators: happens after, tend to lag economic performance
* levels of consumer debt, unemployment rate
Define the Business Cycle and what is the industry relationship to this?
Business Cycle: the recurring pattern of expansions and contractions in the economy
Industry relationship to business cycle — different industries perform better at different parts of the cycle
At what different points in the cycle do businesses do well?
Heading into a recession:
Sector that excels: Financial stocks (e.g., banks).
Reason: When the economy is slowing down, central banks lower interest rates to make borrowing cheaper and encourage spending. Banks, however, don’t immediately lower the rates they charge their customers for loans. This creates a bigger gap between the low rates at which banks borrow money and the higher rates they charge for loans. This “gap” or “spread” helps banks make more profit, even though the economy isn’t doing well.
- Short: When the economy slows and central banks lower interest rates, banks profit from a delay in reducing loan rates, creating a larger gap between their borrowing costs and what they charge customers.
During a recession:
Sector that excels: Consumer durables (e.g., manufacturers of cars, appliances).
Reason: Low interest rates make financing large purchases more affordable for consumers. People may take advantage of cheap loans to buy durable goods, which leads to better performance for these companies despite the overall economic downturn.
Recovery phase (economy starts to grow):
Sector that excels: Capital goods industries (e.g., manufacturers of machinery, equipment).
Reason: These companies sell products to other businesses, who are cautious about large investments during a downturn. Once the economy shows signs of recovery, businesses regain confidence, increase spending on equipment, and expand operations, leading to higher demand for capital goods.
At the peak of the cycle:
Sector that excels: Basic industries (e.g., oil, gas, metals).
Reason: Inflation tends to be higher at the top of the cycle, but companies in resource-based sectors can pass on higher costs to their customers without significantly hurting demand. This allows them to maintain profit margins despite inflationary pressures.
- At the peak of the economic cycle, inflation rises, but resource-based companies can increase prices without losing customers, because these goods are essential (such as oil for cars) so the demand will remian consistent no matter the circumstance
Heading into another downturn:
Sector that excels: Consumer staples (e.g., food, medicine, household goods).
Reason: As economic conditions worsen, consumers cut back on luxury purchases and focus on essentials. Companies that provide everyday necessities, like food and pharmaceuticals, tend to do well because their products are still in demand regardless of the economic cycle.
- people want to buy cheaper beacuse they have a lot of debt now due to decline in interest, and now, inflation has gone up, therefore, prices of goods have gone up. To save money, they go towards consumer staples
Business Cycles: What is the differnece between structural change vs cyclical change
Cyclical change: caused by the ups and downs of teh business cycle and tend to be temporary
Factors:
* inflation
* interest rates
* international economics
* consumer sentiment
Example: During a recession, consumer spending decreases, but it tends to pick up again as the economy recovers.
Structural change: tend to be permanent changes in the way the industry operates
Factors:
* societal influences
* technology
* poloitical and regulations
Example: The rise of digital technology replacing traditional manufacturing jobs, or the shift from fossil fuels to renewable energy.
Outsourcing manufacturing - to - now working finance/administrative
Define Efficient Markets Hypothesis
Efficient Markets Hypothesis: is a financial theory that suggests that asset prices fully reflect all available information at any given time.
What are the 4 stages of the Industry Life Cycle?
-
Start-Up Stage
○ High growth, technological innovation, significant risk (e.g., early smartphones). -
Consolidation Stage
○ More stable growth, industry leaders emerge. -
Maturity Stage
○ Growth matches the economy, competition focuses on price, lower margins. -
Relative Decline
○ Industry growth slows or shrinks due to obsolescence or competition
What are the one of a business’s sensitivities to the business cycle?
Operating Leverage
○ Firms with more fixed costs exhibit higher sensitivity to changes in sales.
- Degree of Operating Leverage (DOL): Higher DOL indicates higher sensitivity.
