Economic Analysis

Economies and Markets

A strong relationship exists between

the economy and the stock market

 Securitymarkets reflect what is going

on in an economy because the value
of an investment is determined by
 its expected cash flows
 required rate of return
Economic Activity and
Security Markets

Stock Market As A Leading Indicator

 Stock prices reflect expectations of
earnings, dividends, and interest rates
 Stock market reacts to various leading
indicator series
 Stock prices consistently turn before
the economy does
Cyclical Indicator Approach to
understand the Economy

This approach contends that the

aggregate economy expands and
contracts in discernable periods
Cyclical indicator categories
 leading indicators
 coincident indicators
 lagging indicators
Cyclical Indicator Categories
 Leading indicators – economic
series that usually reach peaks or
troughs before corresponding peaks
or troughs in aggregate economy
activity
Lead Indicators
 Manufacturers order book
 Capital goods order book
 Index of stocks
 Money Supply
 Interest Rate Spreads
 Consumers Business Confidence
Index
 Unemployment rate
Cyclical Indicator Categories
 Coincident indicators – economic
series that have peaks and troughs
that roughly coincide with the peaks
and troughs in the business cycle
Coincident Indicators
 IIP
 Corporate earnings
 Employees payrolls
 Inflation
Cyclical Indicator Categories
 Lagging indicators – economic
series that experience their peaks
and troughs after those of the
aggregate economy
Lag indicators
 Credit expansion
 Bank PLR
 Inventories to sales
Cyclical Indicator Categories
 Other series – economic series that
do not fall into one of the three
main groups
Monetary Variables, the Economy, and
Stock Prices

 Money supply and the economy

 Money supply and stock prices
 Excess liquidity and stock prices
Money Supply and the Economy
 Declines in the rate of growth of the
money supply have preceded
business contraction by an average
of 20 months in US markets
 Increases in the rate of growth of
the money supply have preceded
economic expansions by about 8
months in US markets
Money Supply and Stock Prices
 Excess Liquidity and Stock Prices
Excess liquidity causes interest rates
to fall.
Fall in the interest rates leads to
encouraging investment climate.
Encouraging investment climate leads
to economic activity and capacity building
and restructuring.
Economic activity leads to
improvement in the stock prices.
Money Supply and Stock Prices

Tight liquidity
Tight liquidity leads to less money
being available for the industry
Causes increase in the interest rates
Discourages investment climate and
affects economic activity
Leads to negative sentiments in the
market
Also….
 Increase in money supply puts more
money in the hands of consumers
 Stimulates increased spending
 Businesses increase production
 Raises demand for labor and capital
goods
 Capital markets improve
And…
 If output growth reaches capacity
limits prices begin to rise
 Expect inflation
 Lenders increase the lending rates
 Interest rates rises
 Stock market turns negative
Inflation, Interest Rates, and Security
Prices

 Inflation and interest rates

 generally move together
 investors are not good at predicting inflation
 Inflation rates and bond prices
 negative relationship
 more effect on longer term bonds
 Interest rates and stock prices
 not direct and not consistent
 effect varies over time
The Business Cycle and Industry
Sectors
 Economic trends affect industry
performance
 By identifying and monitoring key
assumptions and variables, we can
monitor the economy and gauge the
implications of new information on
our economic outlook and industry
analysis
The Business Cycle and Industry
Sectors
 Cyclical or Structural Changes
 Cyclical changes in the economy arise
from the ups and downs of the
business cycle
 Structural changes occur when the
economy undergoes a major change in
organization or how it functions
India’s experience….
 In 1995-96 capital formation peaked
at Rs.2,84,557 Cr and accounted for
28.6% of the country’s total economic
output
 The level came down to 18.3% in
2001-02
 The trend has picked up in 2004
 11th Five year plan envisages an
investment of Rs.20 lac Crores and
12th Five year plan Rs.40 lac Crs
India’s experience….
 Steel Industry is investing Rs.55000
Crore to expand capacities
 35 Million tonnes in a century
 65 Million tonnes of fresh capacity in
15 years
 Excess capacities are running out
calling for fresh investments
India’s experience….
 The current growth is not triggered by
consumer demand as in 90s (95-96) but
by investment demand and infrastructure
growth
 Private sector participation is much wider
and enthusiastic (PPP – Private Public
Partnership)
 Public sector accounts for 50-55% of
investments in infrastructure sectors like
Power and Mining.
India’s experience….
 Expansion with an eye on the global
markets
 Change in the mindset and confidence of
companies. Business plans are prepared
much more vigorously. Government’s
support not expected. Reverse FDI is
ticking.
 The current growth trend is more
sustainable than 95-96 boom
 However we are seeing falling growth
rates now
The Stock Market and
the Business Cycle
The Stock Market and
the Business Cycle

peak

trough
The Stock Market and
the Business Cycle
Basic
Industries
Excel

Consumer
Consumer peak Staples Excel
Durables
Excel

Capital
trough Goods Excel
Financial
Stocks Excel
Stocks in various sectors
 Financial
 SBI
 ICICI Bank
 HDFC
Stocks in various sectors
 Consumer Durables
 Videocon International
 Titan Industries
 Whirlpool
 Philips India
 BPL
 Kitchen Appliances India
 Samtel Color
Stocks in various sectors
 Capital Goods
 BHEL
 ABB
 Bharat Forge
 Siemens
 KEC International
Stocks in various sectors
 Basic Industries
 SAIL
 Tata Steel
 ACC
 Hindalco
 Sterlite Industries
 Bharat Aluminium
 Consumer Staple
 HLL
 Britannia
 Colgate Palmolive
 Dabur India
 Cadbury India
 Nestle India
SUMMARY
 Learn to study and understand the
domestic and global economies by
understanding the economic
variables and its implications
 Understand the correlation between
the economies and markets (equity,
debt, forex and commodities)