In this module, we focus on US
economic indicators. However,
the same (or similar) indicators
are released in foreign
countries.
While each indicator alone
cannot provide a full consensus
about the state of the economy.
These indicators can be
evaluated together to make
conclusions about the economy.
Key Economic Indicators
The Bloomberg site provides a monthly Economic Calendar identifying
when each of the reports are released. This calendar in the market
data section of the site, allows the viewer to click on different
reports and see how the different indicators can affect the
economy. The consensus forecast is given for each indicator. An
analysis of the data appears in a report below. Each report has an
analysis below to assist with interpretation. Key economic
indicators (also called market movers) are highlighted.
http://www.bloomberg.com/markets/economic-calendar/
Key Economic Indicators
Key economic indicators are measurements of
different aspects of the US economy that signify
strengths and weaknesses. Economic indicators can
strongly influence movements in financial markets.
However, studying economic indicators can be
challenging because:
1. There is a large volume of economic data that is released
on a daily basis.
Key Economic Indicators
2. In a global market, it is important to study not only US
economic indicators, but also indicators of other countries,
especially industrialized nations such as the United Kingdom,
Japan and major Euro-zone countries (i.e. Germany and
France). This compounds the number of economic
indicators that must be followed.
Key Economic Indicators
3. Some economic indicators
are much more influential than
others. As a student of the
financial markets, it is
important to identify these.
4. The relative importance of these
economic indicators can change
over time. In particular, the
markets will place more emphasis
on economic indicators they
believe that the Federal Reserve is
following in their assessment of
the strength of the US economy.
Key Economic Indicators
5. The economic indicators and the lag time
differ within a period covered. Lag time is the
time between the period the announcement
covers and its release date. Cover different
time periods. Some indicators have different
lag times…the period between the period
covered and its release.
6. What drives financial market movements is
not the “actual data” that is released but,
rather, how this “actual data” compares with
“the consensus forecast” – what major
economists are predicting. Remember,
financial markets are “efficient” meaning all
available market information, including the
consensus forecast, is built into security
prices.
Indicators
1. Employment
• Employment Situation: Released monthly the first Friday of
the following month and breaks down the employment
situation demographically by industry, sector, and geographic
region. The Employment Situation covers more than 500
industries and a few hundred metropolitan areas. The most
watched data of the report is the new non-farm payroll which
shows how many jobs were created in the previous month
outside of the agriculture sector.
Indicators
Employment
Indicators
New Jobless Claims: The jobless
claims report is released every
Thursday and it shows the number of
individuals who filed for
unemployment benefits for the first
time. If the number of first-time files
decreases, it indicates a positive
trend; but if the number of first-time
files increases, it indicates a negative
Because jobless claims are released
weekly, data may be volatile.
Indicators
Employment
Indicators
2. Inflation
Consumer Price Index (CPI): The CPI is a
measure of inflation at the retail level
and is released monthly. It shows the
price change for a fixed basket of goods
bought by an average working class
family. This index is important because
it is used to adjust many different
contracts that affect living standards
(wages, rent, social security benefits).
Indicators
• Producer Price Index (PPI): The PPI is a
measure of inflation at the wholesale level.
The index calculates the price change of the
raw materials that go into the basket of
finished goods.
Indicators
2. Inflation- continued
Indicators
• Core CPI and PPI: The Core CPI and Core PPI
removes food and energy from the price change
calculation. Food and energy are considered the
most volatile elements of the indexes. They are
removed from the core calculation in order to
obtain a more accurate picture of actual price
changes occurring in the economy.
Indicators
3. Gross Domestic Product (GDP)
• The GDP is a sum of all of a country’s
production within a quarter. The US GDP is
released quarterly. GDP is the most
comprehensive economic indicator. A higher
GDP points to a stronger economy. GDP also
can be divided by the population (GDP per
capita) to show a country’s standard of living.
Indicators
3. Gross Domestic Product (GDP)
Continued
GDP = C + I + G + NX
C = Consumption
I = Investments
G = Government Spending
NX = Net Exports = Exports-Imports
Indicators
3. Gross Domestic Product- Continued
Gross Domestic Product is revised in each of the two
months after the initial release. For example, GDP
for the first quarter is released in April and revised
in May and June. These releases can vary
substantially.
The three GDP figures below are for the first quarter
in 2013. As you can see, the actual GDP changed
with each revision from the GDP released in April
to the GDP released in June.
Indicators
Gross Domestic Product (GDP)- Continued
Indicators
4. Consumer Confidence
• Every month, American consumers and
households are surveyed regarding their
views of the economy and employment
Indicators
4. Consumer
ConfidenceContinued
Consumer confidence in the economy can have a great
affect on stocks and bond prices. For example, in a
recessionary economy; where unemployment is high,
consumers will be reluctant to purchase goods and
services, adversely affecting economic growth.
Measures of Consumer Confidence
US Consumer Confidence Index: A monthly survey of
5,000 households taken by The Conference Board that
provides a measure of how confident consumers are
about the economy.
Michigan Consumer Sentiment
Index: A monthly survey
conducted by the University of
Michigan that conducts telephone
surveys in order to gauge the
overall consumer expectations
about the economy.
Retail Sales: A measure of how much
and what goods consumers are buying
from data collected by the US Census
Bureau. This data is released in the
middle of each month for the previous
month. This indicator is important
because retail sales make up about
half of total consumer spending and a
third of the total economic activity.
Strong retail sales data can indicate a
high degree of consumer confidence.
Indicators
5. Housing
• Housing Market Index: A monthly report;
surveying members of the National
Association of Home Builders, that gauges
their perceptions of the overall economy
and the housing market. This indicator is
similar to the Consumer Confidence
indictor because it identifies how willing
people are to buy homes. A willingness to
buy a home shows confidence but an
aversion to buy a home indicates
consumer uncertainty in the economy.
• Other housing indicators are Housing
Starts, Building Permits, New Home Sales,
and Existing Home Sales.
Fundamental Security Analysis
A company’s financial ratios are typically
compared to other companies within the same
industry. For example, Walgreen's ratios are
compared to the ratios of CVS and Rite Aid. This
real life depiction comparing the three
companies is shown at the end of this section.
1. Liquidity Ratio: Measures a company’s
ability to pay off debt. Liquidity ratios are
important to determining if a company is in a
sound financial position and can recover if
unexpected events occur in the company or
the economy.
Current Ratio: The ratio of
current assets to current liabilities.
It shows a company’s ability to pay
off short term debt with its short
term assets. A large ratio indicates
the company is in a sound
position.
2. Quick Ratio: A measure of how well a company can pay off
its short term liabilities with its current assets, not including its
inventory. The quick ratio excludes inventory because inventory
tends to be less liquid, thus difficult to quickly turn into cash
even though it is a current asset.
Quick Ratio = Current Assets - Inventory
Current Liabilities
3. Profitability Ratios: measure how much return a
company can generate with either its assets or equity in the
business.
– Return on Assets: A measurement of how profitable a
company is based on their assets. It shows how many
dollars of net income are generated per dollar of asset.
ROA = Net Income
Total Assets
– Return on Equity: A measurement of how profitable a
company is based on the equity put into the business from
the shareholders. It is the ultimate measure of profitability
from the shareholders’ perspective.
ROE = Net Income
Shareholders’ Equity
4. Price to Earnings Ratio: A measure that shows
the company’s current share price per??? the
current earnings per share. A high P/E ratio
means that the investors are expecting the
earnings to increase in the future. A lower P/E
means that investors do not expect the
company’s earnings to increase significantly.
5. Solvency Ratio: A measurement or measure that shows how
well a company is able to cover its long-term liabilities. It
takes the company’s after tax net profit and depreciation and
divides that by the total liabilities (current and long term).
Example
Example: Refer to the below financial Income Statement
and Balance Sheets from CVS, Rite Aid & Walgreens.
Calculate the companies’ current ratios, quick ratios,
return on assets, return on equity, and price to earnings
ratios. Make a comment on what each ratio says about
the company and compare each ratio denoting which
company has the strongest ratio. (*Note: These Financial
Statements are simplified for the purpose of the example)
CVS Caremark: Stock
Price= $60.32, Earnings
per Share= $3.86
Rite Aid: Stock Price=
$3.41, Earnings per
Share=($0.43)
Walgreens: Stock Price=
$50.54, Earnings per
Share= $2.43
Example
Rite Aid’s Current Ratio is the largest, followed by CVS
and then Walgreens. All of the pharmacies have
current ratios larger than one meaning they are able
to pay off their short term liabilities with their
current assets.
Example
Quick Ratio:
CVS has the largest quick ratio, followed by Rite
Aid and then Walgreens Return on Assets. All of
the ratios are less than one because of the type
of business the companies do. A large portion of
their currents assets is inventory and the quick
ratio takes out inventory from the calculation.
Example
Return on Assets:
All three companies have similar ROAs. In comparison
to each other, Walgreens has the highest ROA meaning
it is more profitable relative to its total assets than CVS
and Rite Aid. *Note that a company’s ROAs are
generally compared with other companies in the same
industry because of the different business structures
within industries.
Example
Return on Equity:
Walgreens and CVS have similar ROEs of 0.12 and 0.10,
respectively. This means that the companies are
generating about 10-12% return on the shareholders’
equity investments. Rite Aid generated negative net
income and negative shareholders’ equity so it is
unprofitable.
Example
Price to Earnings:
Walgreen’s P/E ratio (20.80) is the largest
followed by CVS (15.63). Rite Aid has a negative
P/E ratio (-7.93). Walgreen’s and CVS’s ratios
indicate the investors expect both company’s
earnings to increase. Rite Aid’s P/E ratio shows
that there is little investor confidence for the
company to increase its earnings.
Bond Analysis
Interest rates are the most important
determinant of bond prices. Therefore,
the most important bond market
analysis is interest rate movements.
In particular, “spreads” – the difference
between two interest rates – are closely
followed.
• Term Structure is the study of how
maturity affects interest rates.
1. Yield Curve: A line that plots interest rates of
bonds of similar credit rating but with different
maturities. The yield curve is most notably linked
with US Government (Treasury) Bonds. The Treasury
yield curve is used as a benchmark for determining
interest rates for other bonds. Yield curves are more
often described by their slope or shape – positively
sloped, negatively sloped, or flat.
The yield curve below represents a “normal” or positively
sloped (shaped) curve. The bonds with shorter maturity
have lower yields and the longer maturity bonds have
higher yields. This is because there is typically greater risk
associated with holding bonds for a longer time. A
positively shaped yield curve also indicates that the market
expects interest rates to increase in the future.
Negative, or inverted,
curves are indicative
of a weakening
economy where the
market believes
interest rates will
decline in the future.
2. Credit Differentials: Studying two or more
bonds with the same maturity but different
credit quality to demonstrate how credit
quality affects interest rates.
Bonds
Example: 10-Year AAA-rated bond vs. 10-Year
Junk Bond
Junk Bonds
• The junk bond should always have
a higher yield than the investment
grade bond because of the added
risk an investor takes on when
buying the bond. However, what
is significant is the size of the
spread.
• A very “wide” spread indicates
that investors are demanding
significantly higher yields (interest
rates) to invest in the lower
quality bond.
• Conversely, a very “narrow”
spread indicates that investors
are willing to accept a lower
amount of incremental (extra)
yield to invest in the lower
quality bond.
• Typically in a recessionary
economy, where consumer
confidence is low, investors tend
to be more risk adverse.
• Consequently, in a strong
economic environment, they will
demand more incremental yield
to invest in the lower quality
bond and the spread will widen.
3. International Interest Rate Differential:
The spread between US Treasury Bonds and
Foreign Government Bonds from other
industrialized countries shows the relative
attractiveness of one nation’s bonds over
another country's bonds.