FINS5568代写、代写Python/Java编程

日期：2022-11-24 09:36

FINS5568 Capstone – Portfolio Management Process

Lecture 4: Economic, Industry and Factor Analysis

Lecture Outline:

Introduction of economic and industry analysis

Business and inventory cycle

Economic growth trend

Industry analysis

Factor investment

Factor construction

Reading:

Maginn, et Al. chapter 4, Reily et al. 2012, chapter 9

Introduction

The goal of economic and industry analysis

Economic analysis help analysts understand the historical relationship between economic

variables and capital market returns

Concerning the direction, strength and lead-lag relationship

Give an analyst many advantages, for example they can better discern or forecast the inflection point

that presents unique opportunities

Industry analysis

Different industries have different return and risk drivers

Firms within an industry tend to be affected by similar forces

Classifying companies using industry provide better discipline and tend to be a good starting point

Most research house assign analysts to cover specific industries

Economic Analysis

Economic

analysis

introduction Economic output tends to have both cyclical and trend

growth component

Trend growth component determines the long-term

return expectation for asset classes, such as equity

Cyclical components affect the short-term corporate

profits and interest rate, which affect stock and bond

return

Within cyclical analysis

Inventory cycle: short-term, 2 - 4 years

Business cycle: long-term, 9 - 11 years

Economic analysis – Cyclical analysis

Measure of economic activities and output:

Gross domestic product (GDP)

Total value of final goods and services produced within a country’s borders in a specific period

Under the expenditure approach: sum of the final uses of goods and services, including consumption,

investment, changes in inventories, government spending and exports minus imports

Economists focus on real GDP, adjusting for the effects of inflation

Economic analysis – Cyclical analysis

Output gap:

The difference between the actual value of GDP and the potential output

Potential output: GDP estimated as if the economy were on its trend growth path

Affect the future inflationary pressure

Negative gap: during recession or slow growth - downward inflation pressure (suppliers reduce prices to

sell inventory as the demand is not strong)

Positive gap: during good economic conditions – spurs inflation (higher demand and price of labor and

goods increase)

Recession:

Broad-based economic downturn

Two successive quarterly declines in GDP (negative growth)

Economic analysis – Cyclical analysis

Inventory cycle

Often measured by inventory to sales ratio

Increase when business have confidence in the future economy and increase inventory to satisfy

future demand – employment also tends to increase – economy tends to grow

At certain point, the measure peaks before subsequent economy slowdown – businesses sell

down inventory and cut production

When the measure bottoms, the economy tends to be strong in the next few quarters

Long-term trend going down due to more effective inventory management techniques, such as

just-in-time inventory management

Order laptops online and will deliver to you within 2 weeks

Economic analysis – Business cycle

Business cycle

Reflects the fluctuation of GDP in relation to long-term trend growth

Business cycle and asset return relationship is well-documented

Five phases: initial recovery, early upswing, late upswing, slowdown and recession

Each cycle is different because of specific events and trends – the phases are different in terms

of duration and severity

Economic analysis – Cyclical analysis

Initial recovery

Duration of a few months

Business confidence is rising

Government stimulation by lower interest rate and/or budget deficit

Large (negative) output gap and falling inflation

Asset class returns:

Bond yield at the bottom (price is high)

Rising stock prices

Cyclical, riskier assets (small-cap stocks and high yield corporate bonds) do well

Economic analysis – Cyclical analysis

Early upswing/expansion

Duration of a year to several years

Increasing growth with low inflation

Increase confidence and inventories by companies

Rising short-term interest rates – central banks withdrawing monetary policy support

(Negative) output gap is narrowing

Asset class returns:

Flat or rising bond yield

Rising stock prices

Economic analysis – Cyclical analysis

Late upswing/expansion

Confidence and employment are high

Output gap closed, inflation increases and the economy is at risk of over-heating

Central banks tend to further tighten monetary policy and rising short-term interest rates

Asset class returns:

Rising bond yield

Rising/peaking stock prices with increased risk and volatility

Economic analysis – Cyclical analysis

Slowdown

Could last from few months to a year or longer

Business confidence falling and reducing inventory

Inflation is still rising due to positive output gap

Short-term interest rates are at peak

Asset class returns:

Bond yield have peaked and start to fall with rising prices

Falling stock prices

Inverted yield curve (short-term yields are higher than the long-term ones)

Economic analysis – Cyclical analysis

Recession

Six months to a year

Decline in inventory, confidence and profits

Increase in unemployment and business bankruptcies

Inflation tops and start to fall

Asset class returns:

Falling short-term interest rates – central banks monetary support

Falling bond yield (rising prices) – investor fly to safety

Stock prices tend to go down until near the end of the recession

Economic

analysis –

inflation

Inflation

Inflation means rising prices (decreasing purchasing

power of currency unit) and deflation means falling

prices

Commonly measured by consumer price indices (CPI):

price of a basket of goods and services

Central banks try to keep inflation low without

succumbing to deflation

High inflation is harmful to the economy

Uncertainty about purchasing power of money -

discourages investment and savings

Very high inflation can lead to social unrest and revolt –

basic goods and services not affordable

Redistribution purchasing power from those with fixed

nominal income (such as pensioners) to those with

variable income (workers whose salary increases with

inflation)

High inflation has been defeated mostly by the end of the

twentieth century

Economic

analysis –

inflation

Inflation tends to accelerate in later stages of business

cycle when the output gap has been closed

Inflation falls during a recession or early years

afterward – large output gap

Deflation can be a threat to the economy because:

Undermines debt-financed asset (such as home

property) and encourages default

Imagine you purchased a house with $1 million with a

$900,000 mortgage but find next year the property is

only worth $800,000.

Reduces central banks ability to stimulate the

economy through reducing interest rate as nominal

interest rate can be very low or close to zero due to

deflation.

Leaving less room for central banks to further reduce

nominal interest rate

Economic analysis – inflation and asset class

returns

Inflation above expectation – inflation shocks:

Cash (positive): rising rates to compensate the higher inflation

Bonds (negative): higher yield due to higher inflation premium

Equity (negative): generally perform better than bonds as companies can potentially pass

on the inflated costs to customers but rising inflation could lead to recession and central

bank tightens policies, which is negative for equities

Real estate and other real assets (positive): asset value (price) and cash flow tend to

increase

Economic analysis – factors affect business

cycle

Consumer and business spending:

Consumer spending amounts 60-70% of GDP for most developed economies and therefore

most important business cycle factor

Data: retail sales and store sales data, tend to have seasonal patterns

The most important factor affecting spending is income after tax

Business spending

Smaller share in GDP compared to consumer spending

But more volatile – business investment can fall by 10-20% or more during recession

Economic analysis – factors affect business

cycle

Monetary policy:

Central banks use monetary policy to adjust the performance of the economy

The goal is to keep growth near long-run sustainable rate

Expansionary monetary policy:

Increase money supply and/or decrease interest rate – encourage business and individual borrowing

and spending, also can lower exchange rate and stimulate exports

Applied during recovery and early upswing phase of the business cycle

Contractionary monetary policy:

Decrease money supply and/or increase interest rate

Applied during late upswing

Economic analysis – factors affect business cycle

Monetary policy – predicting central bank behaviour with the Taylor rule

= + + 0.5 ? + 0.5( ? )

central bank targe nominal short-term rate

short-term interest rate that would be achieved if GDP growths were on trend and

inflation on target

Example 1: What is the short-term interest target if the neutral rate is 2%, inflation target is 2%,

expected inflation is 4%, GDP long-term trend is 2.5% and the forecasted GDP growth is 3%

Solution: 2 + 4 + 0.5(4-2) + 0.5(3-2.5) = 7.25%

Economic analysis – factors affect business

cycle

Fiscal policy:

Government can intervene in the economy through fiscal policy: spending and tax rates

Expansionary fiscal policy:

Decrease tax – leave more money to individual and business for spending

Increase government spending – directly increase the demand for goods and services

Contractionary fiscal policy:

Increase tax and/or decrease government spending

Spending greater than income will lead to government budget deficit

Importantly, it is the change in government spending matters

Changes in government deficit that occurs naturally during business cycle are not stimulative or

restrictive

Economic analysis – factors affect business

cycle

Yield curve:

Relationship between interest rates and maturity of debt securities

Typically upward shape - longer maturity security need to offer higher return for investors –

loss of liquidity, greater interest rate risk

Inverted yield curves have been strong indicators of economic recession

In anticipation of economic downturn, investors buy into long-term safe assets

Drive up the price and long-term asset – lower yield

Economic analysis – factors affect business

cycle

Yield curve:

Economic analysis – factors affect business

cycle

Yield curve:

Sensitive to government policy and economic conditions

Expansionary/stimulative fiscal and monetary policy: upward sloping and economy likely to expand

Contractionary/Restrictive fiscal and monetary policy: downward sloping and economy likely to

contract

Conflicting policy: flat or moderately steep (if monetary policy is stimulative) and the impact on

economy is less clear

Within business cycle:

Steep at the bottom of the cycle, flatten during expansion, flat or inverted at the top of the cycle

Economic analysis – economic growth trend

Economic growth trend:

The long-term growth path of the economy – average growth rate around which the economy

cycles

Economic trends exist independently of the cycle but are related to it

It is key input in the discount cash flow models of expected return

The simplest way to estimate the growth rate is to split aggregate growth trend into:

Growth from changes in employment – labour inputs

Growth in potential labour force size

Growth in actual labour participation

Growth from labour productivity

Growth from capital inputs

Total factor productivity (TFP) growth

Economic analysis – economic growth trend

Example 2: Given the following information, what is the forecast economic growth trend?

Growth in labor force participation: 1.5%

Growth in labor force size: 2%

Growth in capital input: 1%

Growth in TFP: 0.5%

Solution: 1.5% + 2% + 1% +0.5% = 5%

Economic analysis – economic growth trend

Government structural policies: policies that affect the limits of economic growth and

incentives within private sectors:

Pro-growth structural policies:

1. Sound fiscal policy: limited budget deficit and reduce the burden of interest

2. Minimal government intrusion on the private sector and encourage competition in the private

sector - free market tends to more efficient in resource allocation

3. Develop infrastructure and human capital through education and training

4. Sound tax policies

Industry Analysis

Industry analysis

Different industries perform differently during different stages of business cycle

Industry/sector analysis facilitates sector rotation strategy – better predict industry performance

Improve within industry security selection – identify drivers of industry performance and select

securities that benefit the most

Typical patterns of industry performance during business cycle

Financial stocks often recover first towards the end of a recession

Consumer durable goods do well as the economy recovers

Cyclical companies tend to move in anticipation of business cycle

Consumer staples tend to outperform during downturn

Industry analysis

Can examine the variables that drive performance:

High inflation often benefits basic material stocks

High interest rates hurt housing and construction

Weak domestic currency helps exporters

Low growth rates tend to help few companies that can deliver high growth

High energy costs hurt transportation companies, such as airlines

Note that sector rotation strategy might be difficult as each business cycle is different

Industry analysis

Structural Economic changes impact the industry:

Demographics: aging population, shrinking middle-class, and racial and ethnical diversity

Lifestyle: reading habit of different generations, divorce and single parent family

Technology: Amazon’s impact on retail, Uber on local transportation, Airbnb on hotel

Politics and regulation

Factor Analysis

Factor analysis - Introduction

Factors are broad and persistent drivers of return and risks of securities:

Arbitrage pricing model (APT) – Stephen Ross, 1976

There exist multiple factors as compared to the single market factor in CAPM

Equities:

Small size (small firm outperform big firm)

Value (value stocks output growth stocks)

Momentum (past winner tend to outperform losers)

Factor analysis - Introduction

Factors can be captured in systematic and cost-effective ways

Earlier years, factor investment is mostly used by hedge funds

Nowadays, there are numerous smart beta investment funds/ETF:

Target single or multiple factors

Generate extra return but low cost and transparency of index investment

Factor performance can be cyclical:

Momentum: outperform in expansion

Quality: outperform in economic slowdown and recession

Factor analysis – Smart Beta