• 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