TUTORIAL 5 :

Economic Analysis
1) Why should investors be concerned with
GDP growth?
 Real GDP is the single best measure of overall economic
activity.

 If growth in GDP slows, as it did by the end of 2000, corporate

revenues will slow, and profits will slow.

 Against the backdrop of weak GDP, the stock market will react
negatively to this prospect. 2008-2009 was a horrific example
of what happens when GDP growth slows.
2) What is the historical relationship between
stock prices, corporate profits, and interest rate?

 Historically, there is a close direct relationship between corporate

profits and stock prices. A parallel between the two series can
often be seen, both upward and downward, although stock prices
may move first.

 An inverse relationship exists between stock prices and interest

rates. Because interest rates are closely tied to discount rates, a
rise in interest rates will have a negative impact on stock prices.
3) If an investor can determine when the bottoming out of the
economy will occur, when should stocks be purchased –
before, during, or after such a bottom? Would stock price be
expected to continue to rise as the economy recovers?

 Stocks should be purchased before a bottoming of the economy

occurs because prices almost always rise before the trough.

 • As the economy recovers, be prepared for a leveling off, or even a

decline.
4) What does steepening yield curve suggest about
the economy? What about an inverted yield curve?

 A steepening yield curve suggests that the economy is accelerating

in terms of activity as monetary policy stimulates the economy.

 When the yield curve becomes flatter, it suggests that economic

activity is slowing down. An inverted yield curve carries
expectations of an economic slowdown. Every recession since
World War II has been preceded by a downward sloping yield curve.
5) What monetary and fiscal policies might be
prescribed for an economy in a deep recession?

 Expansionary (i.e., looser) monetary policy to lower interest rates

would help to stimulate investment and expenditures on
consumer durables.

 Expansionary fiscal policy (i.e., lower taxes, higher government

spending, increased welfare transfers) would directly stimulate
aggregate demand.
6) Why do you think the index of consumer
expectation is a useful leading indicator of the macro
economy?

 The index of consumer expectations is a useful leading

economic indicator because, if consumers are optimistic about
the future, then they are more willing to spend money,
especially on consumer durables. This spending will increase
aggregate demand and stimulate the economy.
7) Why do you think the change in the index of labor
cost per unit of output is a useful lagging indicator of the
macro economy?
 Labor cost per unit of output is a lagging indicator because wages
typically start rising well into an economic expansion.

 At the beginning of an expansion, there is considerable slack in

the economy and output can expand without employers bidding
up the price of inputs or the wages of employees.

 By the time wages start increasing due to high demand for labor,
the boom period has already progressed considerably.