MAF307

Macroeconomic and Industry

Analysis
Lecture 3
Trimester 2, 2019
Stocktrak.com – Weekly Tasks
• Investment goals
• Initial portfolio
• How to select stocks ?
• Margin trading
• Short selling
 Framework of Security Analysis
Technical Analysis Fundamental Analysis

• No attention on the • Seek intrinsic value of stock

“value” of a stock
• Analysis of the determinants
• Price predictions based to stock prices (e.g. dividends
on historical price and earnings etc.)
patterns
• Approach
 Global/Domestic
• More effective in short
economic analysis
term  Industry analysis
 Company analysis

• More effective in long term

 Framework of Security Analysis

• Fundamental Analysis:

– Macroeconomic analysis

– Industry analysis

– Company analysis

• Top-down vs Bottom Up approach

Macro - Trends

http://www.usfunds.com
 Fund Managers Point of View
- Paul Xiradis (Ausbil Investment Management )
• Australian economies will grow in
We maintain a view that while global and

2019 and 2020, lower bound of growth will be at the

•
potential . Fiscal and monetary stimulus will extend the recovery and market cycle, though the world waits eagerly for the US and China to resolve their trade dispute.

For these reasons, more than ever, we are focused on earnings quality and growth. While risk remains, there are still significant stock-picking opportunities in resources, quality industrials with global growth potential, selected REITs, and companies with
significant global market opportunities.

• We reduced our underweight to banks prior to the election and have further

with a
reduced it following the re-election of the Coalition Government. While APRA proposes to lower the serviceability requirements, and

Coalition Government, banks are more comfortable

and balance sheets will be less challenged than
under the proposed changes from Labor . Earnings, margins and business models have
been under pressure; however, lower rates will help take pressure off. This will provide support for property prices; however, the consumer remains stretched and it may take some time for this to pass through to
growth in earnings for the banks.
• REITs are a case of two markets, retail REITs that are under significant pressure from structural changes in retailing globally, and industrial REITs that are benefitting from the boom in major logistics and
warehousing. We think there is opportunity to benefit from structural change in retail through such REITs as Charter Hall and Goodman Group that are benefitting from the expansion of companies like Amazon.
However, we are underweight traditional retail REITs.

• resources
Finally, significant growth, and are enjoying

strong EPS growth driven by a lower AUD

and global supply constraints.
resource supply interruptions to underpin the iron ore price over the next few years. This supports a strong earnings growth outlook in this sector in 2019 and 2020.
We expect recent failings in the tailings dam at Vale and other

• Source: https://www.livewiremarkets.com/wires/macro-in-action-investing-for-today-s-economy
Economic Activity & Stock Return
Real Aggregate
GDP Corporate
Profit

Real GDP +
EPS
Price Level

Autonomous
Consumption Stock
Return
Household
wealth
From a Distance
Closer Look
There is a relation though…
You may need a Crystal ball
 Global Economic Considerations
• Performance in countries and regions is
highly variable
• Political risk
• Exchange rate risk
– Sales
– Profits
– Stock returns
 Global Political Environment

Political Issues:

• Protectionism and trade policy

• Free Flow of Capital

• Status of a nation’s workforce

 Key Economic Variables

• Gross domestic product

• Unemployment rates

• Interest rates & inflation

• Consumer & Producer sentiment

Interest rate Vs Stock Price

Conventional Wisdom – Inverse Relationship

However other market factors affect this relationship

Government policy and Market

Source: http://www.usfunds.com
 Federal Government Policy

• Fiscal Policy – government spending and

taxing actions.

– Direct policy.

– Immediate impact.

– Slowly implemented.
 Consumer Spending -
Government Cash Handout

https://www.abc.net.au/news/2019-04-26/consumer-spending-and-stimulus-1/11049182
 Federal Government Policy
• Monetary Policy – manipulation of the
money supply to influence economic
activity.
– Initial & feedback effects.

• Tools of monetary policy.

– Open market operations.
– Discount rate.
– Reserve requirements.
 Monetary vs Fiscal Policy
Monetary Policy Fiscal policy

• Direct implementation • Cumbersome

• Roundabout affect • Direct stimulation
• Slow impact on • Immediate impact
investments
 Demand Shocks

• Demand shock – an event that affects

demand for goods and services in the
economy.
– Demand side policies: Fiscal and
Monetary policy

– Increases in government spending

 Supply Shocks
• Supply shock – an event that influences
production capacity or production costs

– Supply side policies: Tax rate cut

– Commodity price changes.

– Educational level of economic participants.

 Business Cycles

• Business Cycle:
– Peak / Boom.
– Trough / Recession.

• Industry relationship to business cycles:

– Cyclical.
– Defensive.
Economic Cycle and Government Response

http://www.usfunds.com
http://www.usfunds.com
 Economic Indicators: Leading
Leading Indicators – tend to rise and fall
in advance of the economy.
Examples:
– Avg. weekly hours of production workers.
– Stock Prices.
– Money supply (M2).
– Yield Curve Slope (10yr Treasury minus Fed fund
rate)
– Initial claims for unemployment.
– Manufacturer’s new orders.
Economic Indicators: Coincident

Coincident Indicators – indicators that

tend to change directly with the
economy.
Examples:
– Industrial production.
– Manufacturing and trade sales.
Cyclical Indicators: Lagging
Lagging Indicators – indicators that tend to
follow the lag economic performance.
Examples:
– Ratio of trade inventories to sales.
– Ratio of consumer installment credit
outstanding to personal income.
INDUSTRY ANALYSIS
 Industry Analysis
• Sensitivity to business cycles.
• Factors affecting sensitivity of earnings to
business cycles:
– Sensitivity of sales of the firm’s product to the
business cycles.
– Operating leverage.
– Financial leverage.
• Industry life cycles.
 Operating Leverage

• Ratio of fixed and variable cost.

• Firms with high fixed cost:

- High operating leverage.

- More sensitive to business conditions.

- Advantageous position in environment of

rising sales.
Degree of Operating Leverage

%Change in operating profits

DOL 
%Change in sales

OR

%ChangeEBIT
DOL 
%Change in sales
 Financial Leverage

• Use of outsiders’ funds.

• Fixed Costs.

• Interest should be paid irrespective of

sales.

• Impact on business cycle sensitivity.

Degree of Financial Leverage

%Change in after tax profits

DOL 
%Change in operating profit
OR

%Change in EPS
DFL 
%Change in EBIT
 Sector Rotation
Portfolio is adjusted by selecting companies that
should perform well for the stage of the business
cycle:
 Peaks – natural resource extraction firms.
 Contraction – defensive industries such as
pharmaceuticals and food.
 Trough – capital goods industries.
 Expansion – cyclical industries such as consumer
durables.
Sector Rotation Strategy
Stock Market Cycle

Health Care, Economic Cycle

Consumer
Non-Cyclicals
Peak

Trough
The Industry Life Cycle

Profit
 Classification of Firms
• Peter Lynch approach:
- Slow Growers – Large, aging companies
- Stalwarts – Large, well – known, non cyclical
- Fast Growers – Small, aggressive new firms
- Cyclicals
- Turnarounds – at or close to bankruptcy …great return
if they can recover
- Asset Plays – has valuable assets that doesn’t reflect
in stock price
Industry Structure and Performance
Determinants of Competition - Porter’s Five Force Model

Potential Entrants

Threat of New Entrants

Bargaining Power of
Suppliers Industry
Competitors
Suppliers Buyers

Rivalry among
Existing Firms Bargaining Power of
Buyers

Threat of Substitute
Products or
Services Substitutes
 Morningstar Economic Moats
• Network effect
• Switching costs
• Intangible assets
• Efficient scale
• Cost advantage
https://youtu.be/ZpHsu7G1IV4
 Revision – MCQ 1
• A decrease in the government deficit
should _______ the level of interest rates.
• A. increase
• B. decrease
• C. sometimes increase and sometimes
decrease
• D. have no effect on
• E. none of the above
 Review Question 2,3,4,5
• You are on a trip around the world.
You study the economy of each
country (from the following slides) that
you visit, and identify the current
phase of its business cycle.
 Review Question - 2
• Country 1. While the landscape is beautiful and the
weather is superb, a lot of people seem unhappy.
Business is slow, and production has dropped steadily
for the past few months. Revenues are down,
companies are laying off workers, and there’s less
money around to spend.

A. Recession
B. Boom
C. Recovery
D. Contraction
 Review Question - 3
• Country 2. Here, people are happily busy.
Almost everyone has a job and makes a
good income. They spend freely, and
businesses respond by offering a steady
outflow of new products.

A. Recession
B. Boom
C. Recovery
D. Contraction
 Review Question - 4
• Country 3. Citizens of this country report that, for a
while, life had been tough; lots of people were
jobless, and money was tight. But things are getting
much better. Workers are being called back to their
jobs, production is improving, and people are
spending again.

A. Recession
B. Boom
C. Recovery
D. Contraction
 Review Question - 5
• Country 4. This place makes you so depressed that
you can’t wait to get back home. People seem
defeated, mostly because many have been
without jobs for a long time. Lots of businesses have
closed down, and those that have managed to
stay open are operating at reduced capacity.

A. Recession
B. Boom
C. Recovery
D. Contraction
 Review Question – 6
An example of a highly cyclical industry is:

• A. the automobile industry.

• B. the tobacco industry.
• C. the food industry.
• D. A and B.
• E. B and C.
 Review Question – 7
In Australia monetary policy is determined by:

• A. Government budget decisions.

• B. Popular mandates.
• C. The Reserve Bank of Australia.
• D. Congressional actions.
• E. None of the above
 Review Question – 8
If the economy is growing, firms with high
operating leverage will experience:

• A. higher increases in profits than firms with

low operating leverage.
• B. similar increases in profits as firms with low
operating leverage.
• C. smaller increases in profits than firms with
low operating leverage.
• D. no change in profits.
 Review Question – 9
• Which of the following are not examples of
defensive industries?

• A. Food producers.
• B. Durable goods producers.
• C. Pharmaceutical firms.
• D. Public utilities.
• E. B and C.
 Review Question – 10
• The life cycle stage in which industry leaders
are likely to emerge is the:

• A. Start-up stage.
• B. Maturity stage.
• C. Consolidation stage.
• D. Relative decline stage.
• E. None of the above.
 Summary
• Fundamental Analysis
– Macroeconomic Analysis
• Economic and Political Factors
• Business Cycles & Indicators
– Industry Analysis
• Leverage
• Industry Life Cycle
• Determinants of Competition