Chapter 2 - Understand the macro-economic environment and its impact on asset classes Flashcards
6 questions on exam, standard
What are the 4 stages of the economic cycle?
-Recession
-Recovery/Expansion
-Boom
-Slowdown/contraction
What is a recession?
Two consecutive quarters of declining Gross Domestic Product (GDP) puts the country into recession. Inflation is low (people aren’t spending) so interest rates are cut (to try to stimulate spending and growth).
The ‘Great Depression’ in the USA in the 1930s is a well-known recession. The UK in the 2000s is another example.
What is the ‘recovery’ phase of the economic cycle?
The recovery phase is where an economy moves out of recession. If GDP is higher than the previous quarter, then the economy is expanding.
What is the ‘boom’ phase of the economic cycle? ?
Strong demand justifies rising prices for many products.
Inflation rises as the public spend their new-found wealth. There is a feel good factor.
Think how after a year of lockdown, people had lots of disposable income that they had saved from being indoors, when lockdown eased there was a lot of spending done.
What is the ‘Slowdown’ phase?
As the economy starts to slow down, sales slow but inflation remains high.
Central banks are reluctant to cut interest rates.
Consumers become more cautious, and start to delay major purchases causing problems for companies and unemployment rises.
What does ‘Fiscal Policy’ mean?
The use of government spending and taxation - The main way the government can influence the economy
- In a recession, they may increase spending or cut taxation to stimulate demand
- In a ‘boom’, they may reduce spending or increase taxation to dampen demand
- Effect on Individuals- tax treatment of assets will influence investment decisions
- Effect on Companies- affect dividend policy and how it raises capital (debt or equities)
What is monetary policy?
Monetary policy is all about interest rates and money supply
Interest rates - BoE control increase/reduction
Money supply - Amount of money in circulation, physical and digital
Money supply
M0 (Narrow money)
Notes and coins in circulation
Banks’ operational deposits within BoE
- M0 reflects changes in economic cycle but does not cause them
- A growth in M0 indicates consumer spending is high.
- Reduction means low spending
Money supply
M4 (Broad money)
- All of M0 plus;
- Instant access account funds
- Time deposits of UK residents with UK banks & building societies
- Is increased by loans from banks, as they put money into accounts of the individuals when loan is agreed, which in turn puts more money into the economy as that money is spent
What do the BoE do if they want to reduce money supply?
Offer GILTS at attractive rates so the public purchase them.
M4 is increased as the money supply reduces
What do the BoE do if they want to increase money supply?
They offer to buy back GILTS at attractive rates, also known as quantative easing
M4 is increased as does the money supply
What is globalisation?
The process by which businesses or other organisations develop international influence or start operating on an international scale.
Take advantage by investing in foreign markets and multinational companies with large overseas operations (Apple, Nike etc.). Low skilled, labour intensive industries at a disadvantage.
Think how you can purchase a Mcdonalds in basically every single country in the world. I’m sure if you went to North Sentinel island you could get a Big Mac!
What is Public Sector Net Cash Requirement (PSNCR)
The difference between government’s expenditure and revenue.
How is the Public Sector Net Cash Requirement (PSNCR) affected by economic cycle?
- Recession - Tax income is weak, unemployment grows so PSNCR grows. Need to spend more as more people dependent on state income
- Recovery/Expansion - Tax income rises, unemployment falls, so does PSNCR
- Boom - Tax revenues are at their highest, PSNCR is at its lowest. Gov could reduce borrowing or repay loans
- Slowdown/Contraction - Tax income reduces so PSNCR begins to grow
How the economic cycles affect the different asset classes.
Recovery
GDP has risen in relation to the last economic quarter
- Costs of fixed-interest securities rise.
- Prices of equities start to rise, as the country moves out of recession into the recovery phase.
- People spend more, as they feel more optimistic.
- Businesses sales increase, due to increasing consumer demand.
- Company profits rise.
- Inflation and interest rates remain low.
- PSNCR deficit falls
How the economic cycles affect the different asset classes.
Boom
Economy is growing at its fastest during the economic cycle
- Prices and inflation start to rise.
- Bank of England increases interest rates.
- Yields from fixed-interest securities will need to be higher to remain,
- competitive, so prices will fall.
- Equity prices start to falter, as rises in interest rates affect company profits.
