CHAPTER SEVENTEEN

MACROECONOMIC AND INDUSTRY ANALYSIS

CHAPTER OVERVIEW
This chapter discusses the broad-based aspects of fundamental analysis-macroeconomic and industry
analysis. The analysis is placed in a global context, as markets are becoming more globalized. The
chapter focuses on aspects of the U. S. economy that affect security returns. Leading, coincident, and
lagging indicators are discussed. The chapter concludes with a discussion of industry analysis, including
information sources and the usefulness of the industrial life cycle in security analysis.

LEARNING OBJECTIVES
Upon reading this chapter, the student will have a thorough grasp of the macroeconomic factors that
affect security prices. The student should understand the roles of fiscal and monetary policy in
influencing the economy. The student should also understand why some industry groups are more
affected by macroeconomic factors than others.

PRESENTATION OF MATERIAL
17.1 The Global Economy
Fundamental analysis will often begin with analysis of the economy, as the global economy will have an
effect on individual firm performance. The top-down approach calls for analysis of the economy with the
goal of identifying industries and companies that will perform well in that economic environment.

A top-down analysis of a company begins with an examination of global economic prospects,

demonstrated in Table 17.1. Factors that may have relevance would include political risk and exchange
rate risk are illustrated in Figure 17.1. Unfavorable movements in exchange rates will affect a firm’s sales
and profits.

17.2 The Domestic Macroeconomy

This section introduces a list of key economic variables and their importance as illustrated in Figure 17.2.
Gross Domestic Product, employment, inflation, interest rates, budget deficit and consumer sentiment are
the major ones. Students should recognize that most of the variables that are listed will have some impact
on the prospects of most firms. The extent to which these variables will impact a firm will depend upon
its particular markets.

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17.3 Demand and Supply Shocks
Analysis of the economy will often distinguish between demand and supply shocks. A demand shock is
an event that affects demand for goods and services. A tax cut is an example of a policy action that is
designed to influence demand of economic participants. A supply shock is an event that influences
production capacity of production costs. Higher levels of education for the work force should have the
effect of increasing productivity or reducing production costs.

17.4 Federal Government Policy

This section describes how three major government policies influence the economy. Fiscal policy
involves government spending and taxing actions. Fiscal policy is an attempt to influence the economy in
a direct fashion. Monetary policy involves manipulation of the money supply to influence economic
activity. Market participants pay substantial attention to monetary policy. Tools that are used by the
Federal Reserve to influence the money supply and interest rates include open market operations, the
discount rate and reserve requirements. Finally, supply-side policies focus on productive capacity in an
economy.
17.5 Business Cycles
A business cycle refers to periods of expansion and contraction. A peak is the high point following a
period of economic expansion. A trough is the low point following a period of economic decline.
Companies can be very sensitive to the cycle or they can be defensive companies. Cyclical companies
are firms whose sales and profits are negatively impacted by a decline in the economy. Capital Goods
manufactures are cyclical firm. A defensive firm is one whose performance is not as sensitive to the
performance of the economy. The National Bureau of Economic Research provides indicator series that
are used in the analysis of business cycles. The NBER has sets of indicators for the business cycle.
Leading indicators tend to lead economic performance. Coincident indicators tend to change directly with
the economy. Lagging indicators tend to lag performance. A complete list of the indicators is shown in
Table 17.2 of the text. The relationship between the business cycle and leading and coincident indicators
is shown in Figure 17.3. Table 17.3 provides an economic calendar listing the public announcement dates
and sources for 20 critical statistics of interest. Figure 17.4 illustrates an excerpt of economic calendar the
week of February 25, 2019 and Table 17.4 covers useful economic indicators.

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of McGraw-Hill Education.
17.6 Industry Analysis
Industry analysis identifies industries that are expected to perform well in the future. Some industries,
such as capital goods are very sensitive to economic performance. The sales of capital goods industry are
heavily influenced by the performance of the economy. Manufacturers do not purchase capital goods for
expansion if the economy is not predicted to perform well. In addition to sales sensitivity, industries that
employ significant levels of operating and financial leverage are more sensitive to economic performance.
Industries have life cycles that will impact their performance independent of performance of the
economy. The importance of industry analysis is shown here. The variation in Return on Equity (ROE)
for different industries is extreme, exemplified by Figure 17.5. Firms in the same industry group can also
experience significant variability in ROE, exemplified in Figure 17.7. Stock performance also
demonstrates significant variability, seen in Figure 17.6.
Examples of NAICS industry codes are shown in Table 17.5. Difference in cyclicality is shown by
comparing the sales of cigarettes and passenger cars and graphically presented in Figure 17.8 with a
jewelry and grocery example. Example 17.1 works through an operating leverage problem and the
contribution of operating leverage to cyclicality is shown in Table 17.6. Example 17.2 presents a problem
to further discuss the degree of operating leverage.
Figure 17.10 presents the common sector rotation strategies that are often suggested by participants in the
investing industry during changes in the business cycle shown in Figure 17.9. The key to securing
abnormal performance from such a strategy would depend on the ability to recognize movements in
advance of the other market participants. Please stress to students the difficulty in timing these transitions
correctly.
The chapter then presents common stages of industry life cycles illustrated in Figure 17.11 and the
accompanying pattern of sales growth. Start up industries experience rapid growth in sales. Maturing
industries experience slowing growth in sales. Industries in relative decline commonly experience
declining sales. Students should recognize that any data acquired about a firm, quantitative or qualitative,
must be viewed within the context of that firm’s place within its life cycle.
The chapter concludes with industry level analysis. It looks at factors such as threat of entry, rival
between existing competitors, pressure from substitute products, and bargaining power of buyers and
suppliers. Students should think about these factors with respect to specific real-world companies.

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of McGraw-Hill Education.