Business cycles and markets

Gross Domestic Product (GDP) Attempt to measure economic activity in a

given country during a given year Y = C + I + G + NX

C = consumption I = investment G = government purchases NX = net exports

Usually reported as percent increases, adjusted for inflation

Recent US GDP growth, annualized and inflation-adjusted

Problems with GDP

Data collection is difficult Inflation measurement is difficult Government purchases, unlike the other

components, are coercively financed and may not reflect people’s perceived welfare

GDP is used as a scorecard for the overall economy and an excuse for government economic interventions and manipulations

Recession

A recession is generally defined as two consecutive quarters of declining real GDP.

A private organization, the National Bureau of Economic Research, issues pronouncements, long delayed, as to when recessions began and ended.

The recent “Great Recession” ran from Dec. 2007 to June 2009.

The recovery has been very slow

Interest rates

Interest rates are a price Price savers receive for delayed gratification Price borrowers pay for quicker gratification

Interest rates in free markets are set by supply and demand

Savers supply funds on which they wish to earn dividends or interest

Businesses borrow funds (or raise equity capital) to finance projects

Fed manipulation of interest rates

The Federal Reserve sets or strongly influences short-term interest rates

Since the Great Recession it has also influenced longer- term rates

Reduced interest rates send false signals to borrowers that suggest savers are more future-oriented than they really are

Businesses focus more attention on long-term projects which are highly interest-sensitive

Boom and bust

Eventually the false signals become evident and some long-term projects are abandoned. A recession begins.

A recession is not something to be suppressed. It is a cleanup of the preceding false boom.

Crowd psychology also plays a role in economic cycles (“booms and busts”)

Stock market cycles

Top down securities analysis

Macroeconomic issues that may affect particular industries

Inflation, current and expected Consumer confidence Government budget deficits Trade balances Prospects of war

Comparing a company with its competitors

Product pipeline versus competitors Ease of entry Depth and significance of patent portfolio

Average smart phone affected by 250,000 patents!

Financial strength: debt burden, cash holdings Earnings, current and projected