mutual investment club of cornell week 3: macro-economics sept. 22, 2010

Mutual Investment Club of Cornell

Week 3: Macro-economics

Sept. 22, 2010


What’s the end goal here?

To be able to read and interpret economic news and how it impacts investment decisions and returns.


Where are we going?

Macro Macro stats to keep any eye on National Income Accounts The Business Cycle Fiscal Policy Monetary Policy/ The Fed


Why bother with the macro stuff?

Macroeconomic events have far reaching implications and can lift up or push down the entire market.

You can have a company figured out almost completely and get completely knocked off your feet by a macro event. Any examples come to mind?

Macro analysis lets you make sector-wide recommendations.


Macro stats: GDP

Gross Domestic Product (GDP) is the market value of all final goods and services made within the borders of a country in a year. Typically correlated with standard of

living. Widely watched as it is an overall measure

of total economic activity in a country. Released Quarterly U.S. GDP right now is about $14.5 trillion.

Recessions are typically characterized by reduced GDP ==> more later.


Macro Stats: Industrial Production & Capacity

Utilization Industrial Production is a measure of

output that focuses on manufacturing and industry. Used to measure the resilience of the

manufacturing side of the economy, specifically.

Capacity Utilization The percentage of total factory capacity

that is used at a given time.


Macro Stats: Unemployment Rate

The Unemployment Rate is the percentage of the labor force that is not employed. The labor force is everybody who is

employed or has sought employment in the last month.

Excess unemployment can be caused by a lack of demand in the economy (cyclical) or a greater mismatch between workers and jobs (structural)

In the U.S., unemployment is 9.6%, up from about 4.5% in 2007.


Macro Stats: Inflation

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. In the long run, the price level is

determined by the amount of money in the economy.

Milton Friedman: “Inflation is always and everywhere a monetary phenomenon.”

A little inflation (~ 2-3%) is good for the economy, but too much is very very bad.


Interest Rates

Interest Rates refer to the yearly cost of borrowing money, expressed as a percentage. When rates are high, businesses are less

willing to invest in new projects, since they can earn a better return in the market, and consumers will consume less, since they earn a higher return on their savings.

Central banks manipulate interest rates More on that later


Confidence

Consumer Confidence indices try to measure consumer sentiment about the state of the economy. High consumer confidence signals that

people will support high demand. Business Confidence indices measure

how businesses feel about the state of the economy. High business confidence signals that

businesses may be ready to hire and invest.


National Income Accounting

Y = C + I + G + NX

Y = GDP/National Income C = Private Consumption I = Business Investment G = Government expenditures NX = Net Exports = Exports - Imports


The Business Cycle: Symptoms Recessions (contractions in economic

activity) will typically be accompanied by: Falling GDP Rising Unemployment Lower inflation (but not always) Lower consumer sentiment Indeterminate effect on interest rates


The Business Cycle: Causes

Demand shocks Fiscal shocks *Monetary policy* Private spending Sectoral shifting

Real shocks Oil embargos, and the like

Notoriously hard to predict


Fiscal Policy

Fiscal Policy refers to the taxing and spending decisions of the government. Some mainstream schools of thought say

that the government can stimulate the economy by spending money and/or cutting taxes.

Widely debated and controversial. May be true but not enough to be worthwhile. Ricardian Equivalence Proposition

Good to know, but the government never does anything right, so let’s move on.


Monetary Policy: The Fed

The Federal Reserve System is the central bank of the U.S.: it controls how much money is in the economy at any given time. Banks have accounts at the Fed, as

strange as that sounds. The Fed’s decisions are thoroughly

watched and scrutinized, as they have strong effects on the macroeconomy. Caused the great depression?


How does the Fed Control M? If the Fed wants to inject money into

the economy (say, to stimulate it; more soon), they will buy U.S. treasury bills from the public for essentially newly printed cash. This is also called injecting liquidity into the economy, as the Fed is exchanging illiquid assets for cash.

If the Fed wants to take money out of the economy, they will sell U.S. treasury bills to the public and receive cash.


What does this do?

Without getting into the technicals, When the Fed pumps money into the

economy, it tends to lower interest rates. Lower rates mean: More business investment Less consumer saving

When the Fed takes money out, it tends to raise interest rates. Higher rates mean: Less business investment Less consumer saving


What does this do?

So when the Fed injects money into the economy, it has a stimulative effect, and vice-versa. In the long run, expansionary monetary

policy translates into higher inflation, and contractionary policy leads to deflation.


How the Fed Operates

The Fed is entrusted with a “dual mandate.” Their goal is to maintain “full employment” and “price stability.” (That’s mostly baloney)

The Fed typically sets a target federal funds rate (the rate at which banks make short-term loans to each other from excess reserves at the Fed) and buys and sells treasuries until the rate is reached. You will typically see the looseness of

monetary policy quoted in terms of a target fed funds rate.


What is Money?

3 common definitions: M0: physical currency + bank reserves

at the Fed M1: M0 + checking accounts M2: M1 + saving accounts, money

market accounts, and a few other things.

These figures give us a better idea of how much money is actually in the economy.


Your definition matters: M0


Sector Analysis

We mentioned before that we can use macroeconomic ideas to make investment decisions on a sectoral basis.

Suppose that we anticipate the economy performing worse than expected next year, but we would still like to be invested in stocks. What would we do?


Defensive Stocks

We would want to look at companies whose profitability will not take as big of a hit. Defense (revenue from government

contracts) Non-cyclical consumer goods (food, etc.) Utilities Health care/pharmaceuticals

We call stocks like this “defensive stocks” Underperform on the way up Overperform on the way down


Kraft Foods vs the Market


Sector Analysis

We can also use sectoral analysis on the way up.

Suppose you feel that the macroeconomy will recover over the next year, more so than current forecasts. How might you try to profit from this?


Cyclical Stocks

Buy stocks in sectors whose profitability will increase more than average as the economy recovers. Consumer cyclical (cars, appliances) Luxury goods Technology Financials (sort of)


Sony vs the Market


See you next week

Thanks for coming!

mutual investment club of cornell week 3: macro-economics sept. 22, 2010

Documents

macro macro stats

investment decisions

later slide

macro analysis

macro event

macro stuff

inflation inflation

economy cyclical