Education Series

Education Series Zachary Peskin Senior Analyst for Macroeconomy

What’s the end goal here? • To be able to read and interpret economic news and how it impacts investment decisions and returns.

Where are we going? • Macro • Macro stats to keep any eye on • National Income Accounts • The Business Cycle • Fiscal Policy • Monetary Policy/ The Fed

Why bother with the macro stuff? • Macroeconomic events have far reaching implications and can lift up or push down the entire market. • You can have a company figured out almost completely and get completely knocked off your feet by a macro event. • Any examples come to mind? • Macro analysis lets you make sector-wide recommendations.

Macro stats: GDP • Gross Domestic Product (GDP) is the market value of all final goods and services made within the borders of a country in a year. • Typically correlated with standard of living. • Widely watched as it is an overall measure of total economic activity in a country. • Released Quarterly • U.S. GDP right now is about $14.5 trillion. • Recessions are typically characterized by reduced GDP ==> more later.

Macro Stats: Industrial Production & Capacity Utilization • Industrial Production is a measure of output that focuses on manufacturing and industry. • Used to measure the resilience of the manufacturing side of the economy, specifically. • Capacity Utilization • The percentage of total factory capacity that is used at a given time.

Macro Stats: Unemployment Rate • The Unemployment Rate is the percentage of the labor force that is not employed. • The labor force is everybody who is employed or has sought employment in the last month. • Excess unemployment can be caused by a lack of demand in the economy (cyclical) or a greater mismatch between workers and jobs (structural) • In the U.S., unemployment is 9%, up from about 4.5% in 2007.

Macro Stats: Inflation • Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. • In the long run, the price level is determined by the amount of money in the economy. • Milton Friedman: “Inflation is always and everywhere a monetary phenomenon.” • A little inflation (~ 2-3%) is good for the economy, but too much is very very bad.

Interest Rates • Interest Rates refer to the yearly cost of borrowing money, expressed as a percentage. • When rates are high, businesses are less willing to invest in new projects, since they can earn a better return in the market, and consumers will consume less, since they earn a higher return on their savings. • Central banks manipulate interest rates • More on that later

Confidence • Consumer Confidence indices try to measure consumer sentiment about the state of the economy. • High consumer confidence signals that people will support high demand. • Business Confidence indices measure how businesses feel about the state of the economy. • High business confidence signals that businesses may be ready to hire and invest.

National Income Accounting • Y = C + I + G + NX • Y = GDP/National Income • C = Private Consumption • I = Business Investment • G = Government expenditures • NX = Net Exports = Exports - Imports

The Business Cycle: Symptoms • Recessions (contractions in economic activity) will typically be accompanied by: • Falling GDP • Rising Unemployment • Lower inflation (but not always) • Lower consumer sentiment • Indeterminate effect on interest rates

The Business Cycle: Causes • Demand shocks • Fiscal shocks • *Monetary policy* • Private spending • Sectoral shifting • Real shocks • Oil embargos, and the like • Notoriously hard to predict

Fiscal Policy • Fiscal Policy refers to the taxing and spending decisions of the government. • Some mainstream schools of thought say that the government can stimulate the economy by spending money and/or cutting taxes. • Widely debated and controversial. • May be true but not enough to be worthwhile. • Ricardian Equivalence Proposition • Good to know, but the government never does anything right, so let’s move on.

Monetary Policy: The Fed • The Federal Reserve System is the central bank of the U.S.: it controls how much money is in the economy at any given time. • Banks have accounts at the Fed, as strange as that sounds. • The Fed’s decisions are thoroughly watched and scrutinized, as they have strong effects on the macroeconomy. • Caused the great depression?

How does the Fed Control M? • If the Fed wants to inject money into the economy (say, to stimulate it; more soon), they will buy U.S. treasury bills from the public for essentially newly printed cash. This is also called injecting liquidity into the economy, as the Fed is exchanging illiquid assets for cash. • If the Fed wants to take money out of the economy, they will sell U.S. treasury bills to the public and receive cash.

What does this do? • Without getting into the technicals, • When the Fed pumps money into the economy, it tends to lower interest rates. Lower rates mean: • More business investment • Less consumer saving • When the Fed takes money out, it tends to raise interest rates. Higher rates mean: • Less business investment • Less consumer saving

What does this do? • So when the Fed injects money into the economy, it has a stimulative effect, and vice-versa. • In the long run, expansionary monetary policy translates into higher inflation, and contractionary policy leads to deflation.

How the Fed Operates • The Fed is entrusted with a “dual mandate.” Their goal is to maintain “full employment” and “price stability.” • (That’s mostly baloney) • The Fed typically sets a target federal funds rate (the rate at which banks make short-term loans to each other from excess reserves at the Fed) and buys and sells treasuries until the rate is reached. • You will typically see the looseness of monetary policy quoted in terms of a target fed funds rate.

What is Money? • 3 common definitions: • M0: physical currency + bank reserves at the Fed • M1: M0 + checking accounts • M2: M1 + saving accounts, money market accounts, and a few other things. • These figures give us a better idea of how much money is actually in the economy.

Your definition matters: M0

Sector Analysis • We mentioned before that we can use macroeconomic ideas to make investment decisions on a sectoral basis. • Suppose that we anticipate the economy performing worse than expected next year, but we would still like to be invested in stocks. What would we do?

Defensive Stocks • We would want to look at companies whose profitability will not take as big of a hit. • Defense (revenue from government contracts) • Non-cyclical consumer goods (food, etc.) • Utilities • Health care/pharmaceuticals • We call stocks like this “defensive stocks” • Underperform on the way up • Overperform on the way down

Kraft Foods vs the Market

Sector Analysis • We can also use sectoral analysis on the way up. • Suppose you feel that the macroeconomy will recover over the next year, more so than current forecasts. How might you try to profit from this?

Cyclical Stocks • Buy stocks in sectors whose profitability will increase more than average as the economy recovers. • Consumer cyclical (cars, appliances) • Luxury goods • Technology • Financials (sort of)

Sony vs the Market

See you next week • Thanks for coming!

Education Series