- Fundamental Analysis
- Macro Analysis
- Effect on Markets
What is Fundamental Analysis
- Fundamental analysis is the cornerstone of investing
- It is the study of all the relevant factors that affect an economy, market or asset class in order to find its intrinsic (fair) value
- Analysis of factors affecting the economy as a whole is known as macroeconomic analysis
- Analysis of the factors affecting a specific company is known as microeconomic analysis
What is the Intrinsic Value
- Fundamental analysis assumes that the price on the stock market does not fully reflect a stock’s “real” value
- This “real” value is known as the stock intrinsic value
- The second assumption of fundamental analysis is that in the long run, the stock price will reflect the fundamentals
- If this intrinsic value is above the current market price, then the asset is underpriced and should be bought
- If the intrinsic value is below the current market price, then the asset is overpriced and should be sold
Macroeconomic Analysis
- Macroeconomic analysis is used in the evaluation of currencies, bonds, commodities, and stock indices
- At the macro level, analysis examines factors that affect the economy in its entirety
- Interest rates, inflation, rate of growth, employment, politics, and national sentiment
- This analysis will tell us if the economy is expanding or contracting or if its booming or in a slump
Economic and Business Cycle
- From boom going into recession the economic growth will slow and we will witness a decrease in investments and production
- From recession to slump inflation will drop and unemployment will rapidly increase
- From slump to recovery interest rates will decrease and housing activity and spending will increase
- From recovery to boom we have growth, spending will increase, inflation will rise, and employment will reach its full capacity
- Where we are in the cycle decides on which asset class we should invest in. e.g. in recession stocks go down and bonds up
Microeconomic Analysis
- Microeconomic analysis is used in the evaluation of individual stocks or corporate bonds
- The term refers to the analysis of the economic well-being of a financial entity as opposed to only its price movements
- Traders analyze the financial statements of a company in order to decide if its stock is a good investment
- Is the company’s revenue growing? Is it making profits?
- Can it repay its debts? What is the fair value of its stock?
- In the long run, a stock’s price is driven by a company’s ability to grow sales and earnings but also the economic conditions
- Interest rates
- Inflation
- Growth
- Employment
- Politics & Sentiment
Macroeconomic Analysis
- Macroeconomic analysis is used in the evaluation of currencies, bonds, commodities, and stock indices
- At the macro level, analysis examines factors that affect the economy in its entirety
- Examples include: Interest rates, inflation, rate of growth, employment, politics, and national sentiment
- This analysis will tell us if the economy is expanding or contracting or if its booming or in a slump
Macroeconomic Analysis – Interest Rates
- The Interest rate is the cost of borrowing money – either by individuals, companies or even governments
- If people and companies borrow less, they have less money to invest and to spend and vice versa
- If interest rates go up this will result in more savings and less spending and eventually lead to a decrease in growth
- If interest rates go down this will result in higher borrowing and higher spending and lead to an increase in growth
- Central banks meet monthly to set interest rate levels and these meetings are closely followed by market traders
Interest Rates Effect on Markets
Macroeconomic Analysis – Inflation
- Inflation is the increase in the prices of goods and services in the economy
- When inflation increases more money is needed to purchase the same goods and services resulting in a decrease in growth
- Consumer Price Index (CPI) measures inflation by measuring the changes in the price of a “market basket” of goods
- The Producer Price Index (PPI) also measures inflation through the change in the production prices of goods and services
- Inflation affects the economy directly as high inflation rates prompt central banks to increase interest rates
Inflation Effect on Markets
Macroeconomic Analysis – Growth
- Growth measures the health of an economy through the increase in the goods and services produced
- The Gross Domestic Product (GDP) which measures the value of all goods and services produced within a country
- The International Trade Balance which measures the difference between imports and exports
- Retail Sales measures growth through consumer expenditure and is used to access the direction of an economy
Growth Effect on Markets
Macroeconomic Analysis – Unemployment
- One of the most important ingredients of a healthy economy is the availability of well paid jobs
- When a person is actively searching for employment but is unable to find work, unemployment occurs
- The unemployment rate is basically the percentage of people in the work force without jobs but are able and willing to work
- Non-Farm Payroll measures employment through the number of additional non farming jobs that are added each month
- An increase in unemployment (decrease in Non Farm payrolls) signals a slowdown in the economy
Unemployment Effect on Markets
Macroeconomic Analysis – Political Stability
- Political risk is the risk that an investment’s return could suffer as a result of political changes or instability in a country
- There are a variety of decisions governments make that can affect businesses, industries and the overall economy
- These include nationalization, higher taxes, extra regulations, barriers to trade and many more
- The decision of the UK to leave the EU, and the election of Trump, created more talk about political risk than before
Political Risk Effect on Markets
Macroeconomic Analysis – Sentiment
- Sentiment is a psychological measure of how people feel about the economy in general or an asset class in particular
- Sentiment can be a very powerful influence on the markets if people see a range of factors as being all positive or negative
- Positive sentiment is referred to as bullish and negative sentiment is referred to as bearish
- Purchasing Managers Index (PMI) and IFO (Institute for Economic Research) measures business managers sentiment
- The Consumer Sentiment Index measures consumer’s opinion and feelings towards the financial health
Sentiment Effect on Markets
Macroeconomic Analysis – Conclusion
- The above indicators provide us with a view on the current and future prospects of the economy
- Changes in the above fundamentals will directly affect the valuation of currencies, bonds, commodities, and stocks
- Market participants should keep a close eye on these fundamentals and use them to take informed trading decisions
