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Business Cycles and

Global Economy
MSL 782

Lecture 3: Equities

Semester II 2021-22
Announcement
• Quiz today
• Exam schedule
• 22nd Jan 2023, 3.30 pm to 4.30 pm
Shift to 12.30 pm to 1.30 pm – discussed among the
students
• Select the group leader and share the name with
Zeeshan by Friday
Today’s topic
• Equity and cycles
• How to identify the cycles?
Aspects of business cycles
• Identification
• Nature
• Drivers
• Indicators
Contested views
• Fluctuation/Deviation from trend – Mainstream
• Exogenously driven
• Random shocks are transmitted to the domestic
economy
• Recurrent cycles – Heterodox
• Endogenously driven
• Profit, demand, etc.
Equity market
What is an equity?
• It is a piece of paper issued by a company which
entitles the owner to a proportion of the income or
profit earned by the company.
• The income accruing to the owner of the equity is
referred to as a dividend.
• The amount of dividend paid in relation to the value
of an individual share is called the dividend yield.
• Dividend yields tend to be higher than interest rates
on long-term government bonds reflecting the
relatively greater risks involved with owing shares
Historical dividend yield: 1971
Oct-2023 Jan
16

14

12

10

0
1871-02-28 1894-02-28 28/02/1917 29/02/1940 28/02/1963 28/02/1986 28/02/2009
Equity investment
• Share
• Index
• Mutual funds
• ETF
Cyclical investment
BSE Gain
Downswing 02/03/2015 08/02/2016
29448.9 22986.1 -21.95
Upswing 08/02/2016 10/02/2020
22986.1 41257.7 79.49
Downswing 10/02/2020 30/03/2020
41257.7 27590.9 -33.13
Upswing 30/03/2020 05/10/2020
27590.9 40509.5 46.82
What drives equity?
• Economic growth
• Corporate earnings
• Policy
• Confidence
• Political factor
Economic growth
• Potential in Asian countries
• Manufacturing
ACs vs EMs stock index:
Relativised
400

350

300

250

200

150

100

50

0
Dec 31, 1987 Feb 28, 1994 Apr 28, 2000 Jun 30, 2006 Aug 31, 2012 Oct 31, 2018
Source: MSCI, author’s calculation
China takes over as the leading
global manufacturer
35

30
Share of manufacturing

25

20

15

10

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

China India Japan

United States European Union

Source: World Bank WDI, NBER, figure by author

Manufacturing driving global growth:
World manufacturing and World GDP

% growth (real)

6 10
Manufact uring
(left )
4 5

2 0
GDP
0 -5

-2 -10
1995 97 99 01 03 05 07 09 11 13 15 17

Source: World Bank, Kapital Econom ics

Profits driving economic growth
in China: 2007-2018
y-o-y % change, rolling 12 months

60 20

45 15
Growth proxy composite (Right)
30 10

15 5

0 0

-15 -5
Industry profits
-30 -10
07 08 09 10 11 12 13 14 15 16 17 18

Source: National Bureau of Statistics China

India relative to EMs: Relativised
350

300

250

200

150

100

50

0
Dec 31, 1992 Apr 30, 1998 Aug 29, 2003Dec 31, 2008 Apr 30, 2014 Aug 30, 2019
Source: MSCI, author’s calculation
BSE and Nasdaq-100
1800
1600
1400
1200
1000
800
600
400
200
0
1 82 163 244 325 406 487 568 649 730 811 892 973 1054113512161297
Nasdaq normalised BSE normalised
Source: Yahoo finance
Growth
Additional information for recap
Defining growth
• Economic growth = increase in total output of
goods and services in an economy
• Rate of growth = the expansion of physical output
in any given year in relation to the total level of
physical output in the preceding year.
Composition of Aggregate Output
Sector Sub-sector
Agriculture Food production
Fisheries
Forestry
Industry Manufacturing
Mining and quarrying
Export processing
Construction
Services Transport
Electricity, communications, water and sanitation etc.
Trade (wholesale, retails)
Financial and real estate
Hotels and tourisms
Public administration
Measuring economic growth
• The conventional measure is Gross Domestic
Product at constant prices
• Survey data
• Estimates
• Another measure is Gross National Product at
constant prices
Calculating GDP
• Expenditure approach = C + I + G + (X-M)
• C: Personal consumption
• I: Investment
• G: Government expenditure – budget deficit
• X-M: Trade, Export minus Import – trade surplus
• What is the source of growth?
Neoclassicals: Long-run growth
• Traditional Neoclassical growth theory
• Growth is seen as a function of growth in labour supply
(population) and exogenously given technological
change (or factor productivity)
• The rate of savings is seen as irrelevant after an
equilibrium long-term real interest rate has been
attained
• New Growth theory
• Technological change is seen as endogenous and
dependent on investment.
• Since savings determine investment the rate of savings
now matters
Neoclassicals
• A rise in aggregate money expenditure does not
lead to a rise in aggregate real output (although it
will lead to rise in aggregate money output)
• A rise in aggregate money expenditure will lead to
inflation and a deterioration of the BoP
• A rise in aggregate money expenditure is principally
due to an increase in the money supply (and a fall
in interest rates)
• Aggregate real output will only increase as a result
of changes in the conditions of production
Composition of Aggregate
savings
• If factor owners do not spend their money income on
consumption goods then they are deemed to save it
• It is assumed money saved is spent on investment
goods – to expand production (i.e., S = I)

S = Sp + Sg + Sf

• An excess of tax income over government current

expenditure can be seen as (government) saving
• An excess of imports over exports can also be seen as
increasing (foreign) savings in this light
New Keynesians: Long-run
growth
• For some long run growth the same as traditional
Neoclassical (NGT) analyses. For others it is linked
to structural shifts in aggregate demand due to
shifts in income distribution
Heterodox: Long-run growth
• Long cycle (major technological changes)
• Rate of profit (and the implied rate of capital
accumulation)
Neoclassicals
• Short-term cyclical movements in economic growth
are explained by factors alleged to give rise to
cyclical fluctuations in the economy (viz., business
cycles).
New Keynesians
• Short-run cyclical movements in growth are seen as
due to shocks in aggregate demand
Heterodox: Growth
• Juglar cycle (changes in fixed capital investment)
• Rate of profit and expectations about the rate of
profit