Lecture 38: Top Down Analysis

Investment Analysis Top-Down Approach: Market Analysis - Part 1

Introduction to Market Analysis

• Course: FIN 521 Investment Analysis, Instructor: David ZyndaFocuses on stock prices and economy, valuation methodologies, and interest rates' impact on investment decisions.

Key Objectives

1. Relationship between stock prices and economy (GDP growth, inflation).

2. Methodologies for valuation (DCF, price-earnings ratios, comparative analysis).

3. Economic indicators (leading, coincident, lagging) and their role in forecasting.

4. Interest rates' effects on corporate borrowing and consumer spending.

Components of Market Analysis

• Macroanalysis: Examines aggregate market performance against economic indicators.

• Microvaluation: Determines intrinsic stock values based on company-specific factors like earnings and growth potential.

GDP and Corporate Profits

• Near-linear relationship: Rising GDP typically leads to increased corporate profits and higher stock valuations.

Corporate Profits and Stock Prices

• Direct correlation between corporate earnings increases and S&P 500 value; economic growth drives stock performance.

Predicting Stock Prices

• GDP growth patterns are crucial for forecasting, though timing and market movements complicate predictions.

Alternative Economic Measures

• Utilize leading (predict future performance), coincident (current conditions), and lagging indicators (confirm trends) for economic health evaluation.

Key Indicators

• Leading: Average weekly hours, ISM new orders, consumer expectations, interest rate spread, stock prices.

• Coincident: Nonagricultural payrolls, personal income, industrial production, manufacturing and trade sales.

• Lagging: Average prime rate, consumer price index, consumer installment credit, inventories to sales ratio.

Consumer Sentiment

• Essential for understanding spending (70% of GDP). Key surveys include the University of Michigan Consumer Sentiment Index and Conference Board Consumer Confidence Index.