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Portfolio Management > Economic Environment > Flashcards

Economic Environment Flashcards

1
Q

How is the stock market performance affected by the economy?

A

Share prices: reflect investors’ expectations of corporate performance (income, cash flow, profit margins).

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2
Q

How is the bond market performance affected by the economy?

A

Is a function of changes in interest rates driven by economic conditions and monetary policy.

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3
Q

Is the stock market cycle ahead of the economic cycle?

A

Yes, the stock market cycle leads the economic cycle.

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4
Q

Why does the stock market lead the economic cycle?

A

Investor decisions based on expectations: expectations of future income, future dividends, future interest rates. These decisions reflect the future state of the economy.

Market reaction to economic indicators: adjustment of analysts’ forecasts and transactions in relation to the level of leading indicators. Share prices become leading indicators.

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5
Q

What is trend growth?

A

LT average growth path of GDP (Fiscal Policy)
Trend growth is of relevance for setting long-­term return expectations for asset classes such as equities.

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6
Q

What is cyclical variation?

A

Cycles. ST/MT movements and turning points
MONETARY POLICY
Cyclical variation affects variables such as corporate profits and interest rates, which are directly related to asset class returns and risk. Short-term.

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7
Q

Wo controls and what regulates the fiscal policy?

A

Fiscal policy: controlled by the various levels of government, it regulates the long-term growth of the economy & directs the local economy according to the priorities of the population.

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8
Q

what are the tools of fiscal policy?

A

Tools: regulation, subsidies, incentives, taxation, tax credits, etc.

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9
Q

Who controls and what is monetary policy?

A

Monetary policy: controlled by the Central Bank, it allows to regulate the economy in the short term.

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10
Q

What are the tools of monetary policy?

A

Tools: discount rate, control of money supply, regulation of financial institutions, influence on the banking system, etc.

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11
Q

What are the priorities of monetary policy?

A

Priorities: usually in this order, the inflation target, achieving full economic potential and maintaining an adequate exchange rate

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12
Q

What are the major approaches to economic forecasting?

A

1) Econometric (statistical) modeling : Analyze changes in indicators on a statistical basis
2) Leading indicator-based approach. Analyze the variations of the indicators based on prices & moving averages.
3) Checklist approach. Analyze changes in indicators based on professional judgment.
4) Mixed analysis models: Analyze indicator changes with the help of more than one of the previous methods of analysis

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13
Q

What is the GSFCI?

A

The Goldman Sachs Financial Conditions Index (GSFCI) is an indicator that reflects the ease or difficulty of financial conditions in the economy.
A lower GSFCI value suggests looser financial conditions, while a higher value indicates tighter conditions.
GSFCI is a weighted average of 8 variables including Fed fund rates, 5-yr / 10-yr treasury note yields, ratio of SP500 to a 10-yr average of EPS, house price index…
The GSFCI is especially relevant to the Federal Reserve’s policy decisions, as the Fed uses financial conditions to gauge the impact of its monetary policy on the economy.

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14
Q

What is excess liquidity?

A

Difference between the annual change in M2 money supply (adjusted for very short-term deposits) and the annual growth rate of nominal GDP.

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15
Q

What happens when there is excess liquidity?

A

Liquidity available to purchase stocks
Increase in stock prices (in abt 12M)

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16
Q

What are economic indicators?

A

Economic indicators are economic statistics published by official agencies and/or private organizations. These indicators contain information on an economy’s recent past activity or its current or future position in the business cycle.

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17
Q

What are the 4 categories of economic indicators (NBER)?

A

lagging
coincident
leading
composite

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18
Q

True or false: The yield curve is inverted
Yield curve inversions precede recessions

A

true

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19
Q

What are some of the leading indicators of the canadian economy?

A

Housing index
Business and personal services employment (in thousands)
S&P/TSX stock price index
Money Supply, M1 (millions of $, 1992)
U.S. composite leading indicator (1992=100)
Average work week (hours)
New orders, durables (millions of $, 1992)
Shipments/inventories of finished goods
Furniture and appliance sales (millions of $,1992)
Other durable goods sales (millions of $, 1992)

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20
Q

What are some of the analytical measures of the evolution of economic indicators?

A

Diffusion indices :
Indicates how the aggregate index has evolved at the level of the different economic actors. It can therefore be seen whether a small or a large proportion of these actors contributed to the fluctuation of the aggregate index.

Rate of change in the value of the index :
Tells if growth is sustained or is running out of steam. As with the diffusion index, the rate of change peaks and hits its bottom before the aggregate index.

Comparison with previous cycles :
Comparing the state of the index with previous cycles, we can deduce the possible variations in future trends.

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21
Q

What is the growth cycle?

A

Refers to fluctuations in economic activity around the long-­term potential or trend growth level.
The focus is on how much actual economic activity is below or above trend growth in economic activity: output gap.

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22
Q

What is the output gap?

A

actual growth rate of GDP - potential growth rate of GDP

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23
Q

What is the potential growth rate of GDP?

A

Growth potential of the economy : Normal and sustainable growth rate given available resources

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24
Q

What are the 4 phases of business cycles?

A

1) recovery
2) expansion
3) slowdown
4) contraction

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25
Q

How is the output gap in recovery?

A

negative and decreasing

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26
Q

What happens in recovery?

A

Recovery of economic growth (rebuilding inventories and business investment). Unemployment remains higher than average.
The increase in demand is satisfied by the existing excess capacity.
Monetary policy remains easy and inflation under control or decelerating.

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27
Q

In recovery, what happens with interest rates?

A

Low short-term interest rates. Return on cash / cash equivalents assets are low. Bond yields bottoming out.

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28
Q

In recovery, what happens with stock prices?

A

Rising stock prices. Cyclical assets and riskier assets such as small-cap stocks and high yield bonds.

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29
Q

How is the output gap in expansion?

A

positive and growing

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30
Q

What happens in expansion?

A

Monetary policy: becoming less stimulative/tightening
Inflation: inflation increasing and good economic growth.

The growth rate of the economy exceeds its sustainable level, and inflationary concerns become real, thus tightening of monetary policy in a preventive way.
Production capacity constraints are important.

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31
Q

How are markets and asset allocation affected in expansion?

A

Rising short-term interest rates. Rising bond yields. Bonds offer poor returns.
Increase in yields of cash and cash equivalents.
Rising/peaking stock prices with increased risk and volatility.
The materials sector is facing excess demand but capacity constraints. This sector is performing even better.
Commodities become attractive as instruments to protect against inflation

32
Q

How is the output gap in slowdown?

A

Positive and decreasing production gap (narrowing gap)

33
Q

What happens in slowdown?

A

Monetary policy: becoming less restrictive.
Inflation still rising.
The effects of the policies adopted to curb growth in Phase 2 are still being felt, pushing the economy towards recession. Markets become very volatile.

34
Q

How are markets and asset allocation affected in slowdown?

A

Short-term interest rates at a peak. Bond yields peaking and possibly falling, resulting in rising bond prices. Possible inverting yield curve.
High interest rates make cash and cash equivalents attractive. These, like bonds, outperform equities.
Falling stock prices.

35
Q

How is the output gap in contraction?

A

negative and growing production gap

36
Q

What happens in contraction?

A

Declining confidence and profits. Increase in unemployment and bankruptcies.
Inflationary pressures lessen and monetary policy becomes more accommodating
Correcting inventories is the major problem of this phase.

37
Q

How are markets and asset allocation affected in contraction?

A

Falling short-term interest rates. Yields on cash and cash equivalents fall. Falling bond yields, rising prices. Bonds perform well.
Stock prices increasing during the latter stages, anticipating the end of the recession and existence of excess liquidity in the system.
Materials sector remains worst in the stock market due to excess capacity

38
Q

Are all sectors equally sensitive to the business cycle?

A

No

39
Q

What factors affect sectoral performance over time?

A

Macroeconomic conditions
Specific sectoral shocks

40
Q

What is sector rotation?

A

Sector rotation is a strategy of rotating portfolio concentration in certain sectors or industries in order to take advantage of the relative performance of these sectors relative to the market in general.
In practice, tactical allocation is essentially done within investment mandates by asset class where managers over or underweight sectors in each of the investment mandates.

41
Q

What are the GICS 11 sector classifications?

A

energy
materials
industrials
consumer discretionary
consumer staples
healthcare
financials
information technology
telecommunication services
utilities
real estate

42
Q

Is the energy sector cyclical?

A

Yes

43
Q

What are the fluctuations of the energy sector influenced by?

A

Fluctuations in the sector are mainly influenced by world energy prices, which are themselves affected by political conditions, reserves and global economic growth.

44
Q

When is the energy sector superior and inferior to the market?

A

Superior to the market: in a period of significant increase in energy prices
Worse than the market: in a period of significant decrease in energy prices

45
Q

Is the material sector cyclical?

A

Yes

46
Q

When is the material sector superior and inferior to the market?

A

Superior to the market : in a period of economic recovery or growth where the rate of utilization of production capacity is high
Worse than the market : in times of slower growth in the economy

47
Q

Is the industrial sector cyclical?

A

yes

48
Q

When is the industrial sector superior or inferior to the market?

A

Superior to the market : at the beginning of a recovery in economic growth
Worse than the market : at the beginning of a recession or slowdown in growth

49
Q

Is the construction sector cyclical?

A

Yes

50
Q

When is the construction sector superior or inferior to the market?

A

Superior to the market : at the beginning of economic recovery; the sub-sector anticipates the economic recoveries.
Worse than the market : when interest rates rise, and economic growth slows

51
Q

Is consumer discretionary cyclical?

A

yes

52
Q

When is the consumer discretionary superior and inferior to the market?

A

Superior to the market : at the beginning of economic growth and in times when growth is greater than the long-term trend
Worse than the market : at the start of a recession or slowdown in growth

53
Q

Is the consumer staples sector cyclical?

A

no

54
Q

When is the consumer staples sector superior and inferior to the market?

A

Superior to the market : in a period of severe contraction of the economy
Worse than the market : at the beginning of the period of economic growth. (anticipation of a favorable economic situation)

55
Q

Is the health sector cyclical?

A

no

56
Q

when is the health care sector superior and inferior to the market?

A

Superior to the market : in times of contraction of the economy
Worse than the market : in times of economic growth

57
Q

Is the financials sector cyclical?

A

yes

58
Q

when is the financials sector superior and inferior to the market?

A

Superior to the market :
in the second half of the recession, when the effect of easier monetary policies is felt
in times of moderate growth

Worse than the market :
in times of great economic growth
when interest rates are rising

59
Q

is the technology sector cyclical?

A

yes

60
Q

when is the technolgy sector superior and inferior to the market?

A

Superior to the market : in times of economic recovery; ahead of recovery, as good performance in the sector reflects investors’ expectations.
Worse than the market : in times of stagnant economic growth or when a contraction/recession is anticipated.

61
Q

is the telecommunications sector cyclical?

A

no

62
Q

when is the telecommunications sector superior and inferior to the market?

A

Superior to the market: usually in times of economic growth.
Worse than the market: in times of slower economic growth.

63
Q

is the utilities sector cyclical?

A

no

64
Q

when is the utilities sector superior and inferior to the market?

A

Superior to the market : in times of stagnant economic growth.
Worse than the market : in times of economic growth.

65
Q

is the real estate sector cyclical?

A

yes

66
Q

when is the real estate sector superior and inferior to the market?

A

Superior to the market: in times of economic growth and decreases in interest rates
Worse than the market: in times of slowdown in economic growth and increases in interest rates

67
Q

In expansion, which are the sectors superior to the market?

A

financials, technology and communication services

68
Q

In expansion, which are the sectors inferior to the market?

A

health care, utilities and consumer staples

69
Q

In slowdown, which are the sectors superior to the market?

A

consumer staples, health care and industrials

70
Q

In slowdown, which are the sectors inferior to the market?

A

consumer discretionary, real estate and materials

71
Q

In recession, which are the sectors superior to the market?

A

consumer staples, utilities and health care

72
Q

In recession, which are the sectors inferior to the market?

A

real estate, tech and communication services

73
Q

In recovery, which are the sectors superior to the market?

A

consumer discretionary, real estate and materials

74
Q

In recovery, which are the sectors inferior to the market?

A

consumer staples, utilities and healthcare

75
Q

What is Quantitative Easing ?
a. An unconventional form of monetary policy where a Central Bank creates new
money electronically to buy financial assets, like government bonds.
b. Open market operations by the Central Bank of buying and selling government
bonds to increase or decrease the money supply.
c. Operation of tapering, which is a reduction of the monetary injection into the
system by the Central Bank.

A

A

76
Q

Regarding the monetary policy of the Central Bank, what is the output gap?
a. Difference between the Nominal GDP and Potential GDP.
b. Difference between the growth rate of the real GDP and the potential growth of the
economy.
c. Difference between the growth rate of the Nominal GDP and the potential growth
of the economy.

A

B

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