Economic Analysis - I

ECONOMIC ANALYSIS
The economy is studied to determine if overall
conditions are good for the stock market.
Is inflation a concern?
Are interest rates likely to rise or fall?
Are consumers spending?
Is the trade balance favorable?
Is the money supply expanding or contracting?
These are just some of the questions that the
fundamental analyst would ask to determine if
economic conditions are right for the stock market.

Economy Analysis
Boom Economy:
Income rise and demand for goods will
increase the industries and companies in
general tend to be prosperous.
Recession Economy:
Income decline and demand for goods will
decrease the industries and companies in
general tend to be bad performance

Economy analysis (cont)

Growth rates of national income(GRNI)
GRNI is an important variable can be
calculated by GDP, to analysis the growth
rate of economy.
Four stages of economy or economic
cycle i.e depression, recovery, boom and
Recession.
Recession of economy of nation also
impact on security performance.

 Depression: At this stage demand is low and

declining inflation often high and so are interest rate,
companies usually reduce activities and securities
performance is poor.

Recovery: Economy begin to revive after

depression, demand pick up leading, production and
activities increase.

Boom: High demand with high investment and

production, companies earn more profit

Recession: Companies slowly begins

downturn in demand, production and
employment, profits are also decline.

Inflation
Inflation prevailing significant impact on
company performance.
High inflation upset company plan.
Demand goes down because purchasing
power fall, high inflation impact company
performance adversely.
Inflation is measured both in WPI
(Wholesale price index) CPI (Consumer
price index)

Interest Rate
Interest rates determine the cost and
availability of credit for companies
operating in an economy.
Low interest rate=> easily and cheaply available
credit.
=> lower cost of finance
=> high profitability

High interest rate => higher cost of production

=>lower profitability
=>Lower demand

Government revenue, expenditure and deficit

Government is the largest investor in economy

of any country thus revenue, expenditure and
deficit have significance impact on the
performance of industries and companies.
Expenditure stimulate demand and creates job.
The excess of expenditure over revenue is
deficit, (budget deficit), most expenditure are
spent on infrastructure, and deficit financing
fuel inflation.

Exchange rate

The balance of trade in import and export determine

the rate of exchange rate.
Depreciation of local currency improve the competitive
position in foreign market the performance of exported
product but it would also make the imported product
more expensive.
A foreign Exchange reserves is needed to meet
several commitments such as payment for import and
servicing of foreign depts.

Infrastructure.
Development of a economy depends very
much on the infrastructure available. Industry
needs electricity for its manufacturing activities
road and railways to transport raw material and
finished good. Communication channels help
supplier and customers.
Good infrastructure is symptoms of development.
Bad infrastructure lead to inefficiencies, low
productivity wastages and delay.
Investors should analysis the infrastructure of any
economy.

Seasonal impact
For example : Indian economy depends on
agriculture sector, the economy is also depend
the performance of agriculture, optimistic
forecasting of weather condition will prosper the
economy condition.
Weather forecasting becomes a matter of great
concern for investor in the economy of
agricultural country.

Global Economy
Global Economy: The economic analysis
should start from the global economy.
Since the economies are interrelated thus
the firms across economies, the international
economy can affect a firms prospects.
It affects the price competition it faces from
competitors, or the profits it makes on
investments abroad

Global Economy contd.

At a particular point of time, there can be
variations in the economic performance
across countries.
Similarly, political risks can be of greater
magnitude in other countries compared to
domestic political environment.
Fluctuations in currency exchange rate
also affect the performance of companies.

GDP Gowth

GDP and emerging economy

Fig in the Prev. Slide depicts the real GDP
growth of developed and emerging
economies. One can see that trend is not
always similar and the pattern in rate of
growth is also different.
The emerging economies show higher
growth in comparison to developed
economies. One need not be surprised
about attraction of investors towards
emerging economies.

Domestic Macro Economy

An analyst should be able to forecast
about domestic macro economy better
than other analysts.
By this, the analyst [for that matter, a fund
manager] can outsmart the peers in
showing investment performance.
The key macroeconomic variables that an
analyst should look at are:

Gross Domestic Product

Measure of the economys total production
of goods and services.
Growth in GDP reflects opportunities for a
firm to increase its revenue by selling more
products or services.

Industrial Growth Rate:

Although part of GDP growth, industry
growth rates indicates the activity in
manufacturing sector of the economy.
Monsoon and Agriculture: For agrarian
economies these two factors are pertinent.
Several industries also depend on
agriculture for inputs. Level of monsoon
indicates the likely performance of
agriculture sector.

Employment and Capacity

Utilization:
The employment of labour as well as other
factors of production [like machine
capacity] indicates the level of economic
activity in the country.

Price Level and Inflation:

The general level of price rise is known as
inflation. When demand for products and
services are higher than the productive
capacity, there can be high inflation. The
governments and monetary regulators like
Reserve Bank of India try to draw a
balance between inflation, growth and
unemployment.

Interest Rates:
Sectors like consumer durables,
automobiles and housing are highly
sensitive to interest rates.
High interest rates also reduce the present
value of investment.

GDP vs BSE Index

Analysing Macro Economy Demand and Supply Shocks:

The different factors that affect the macro
economy can broadly be considered as
demand and supply shocks. Demand shocks
are the events that affect the demand for
goods and services in the economy.

Demand Shocks
Demand shocks are characterized by aggregate
output moving in the same direction as interest
rates and inflation.
For example, reduction in tax rates can increase
the disposable income of the consumers. This is
expected to increase the demand for products
and services, which in turn can lead to increase
in inflation. The events that influence production
capacity and costs are known as supply shocks.

Supply Shocks
Supply shocks are usually characterized
by aggregate output moving in the
opposite direction of inflation and interest
rates. Natural calamity can adversely
affect the production in the economy, thus
reducing the aggregate output and
increase in the cost of production and
output.

 Consumers will not be willing to purchase

the outputs at higher prices.
Overall GDP is likely to fall. Some of the
examples of demand and supply shocks
are given below.
Analysts need to identify industries based
on the demand and supply conditions and
devise the switching strategy [from one
industry to another]

 Government Policy: Governments and

monetary authorities devise policies affecting
both demand and supply conditions in the
economy.
Demand-side Policies are expected to stimulate
the total demand for goods and services. The
two major demand-side policies are fiscal and
monetary policies.

 Fiscal policy denotes the spending and tax

actions of the government and is part of
demand-side management.
Government has to strike the delicate
balance between political condition and
economic stability. Government may
hesitate in curtailing the spending in social
sector because of electoral compulsion

 Increase in tax rates can decrease the

disposable income of the consumers.
But the increased tax collection can facilitate
greater spending by the government for the
economy.
Without appropriate tax collection, the deficit will
increase thus leading to borrowing by the
government. Monetary policy intends to regulate
the money supply to affect the macroeconomy.

 Primarily the effect of monetary policy is seen in

terms of change in interest rate. Expansionary
monetary policy lowers the interest rate and
stimulates investment and consumption demand
in short run. But it can also lead to higher prices,
thus inflation in long run.
Fiscal policy is designed by the government
while monetary policy is designed and
implemented by the monetary authority i.e. the
central bank of the country.

 In conclusion, it is imperative for the investors

and analysts to devise models to forecast the
market and take investment decision or tweak
the existing investments. In the second part of
the module on Economic Analysis, we shall
discuss the tools for economic forecasting
focussing more on the business cycle, economic
indicators, indices etc.