•Budget Deficit
The difference between government spending and revenues.
The deficit should be closed by borrowing.
The government borrowing can increase interest rates and crowd-out the private
borrowing and decrease investment and affect economic growth negatively.
•Economic Indicators
Set of cyclical indicators helps to forecast, measure, and interpret short-term fluctuations
in economic activity.
These indicators can be divided into three general groups as leading, coincident and
lagging.
Leading indicators tend to rise and fall in advance of the economy.
•Examples: averageweekly hours of production workers, stock prices
Coincident indicators tend to change directly with the economy
•Examples: industrial production, manufacturing and trade sales
Industry Analysis
•Defining an industry
•Sensitivity to the Business Cycle
Three factors decide the sensitivity of a firm’s earnings to the business cycle: sensitivity
of sales of the firm’s product to the business cycles, operating leverage, financial
leverage.
1. Sensitivity of sales
•Necessities such as foods, drugs, and medical services will show little sensitivity to business
conditions.
2. Operating Leverage
•Division between variable and fixed costs.
•Firms with more variable costs are less sensitive to business conditions. Firm can reduce costs as
output falls in response to falling sales during economic downturn.
•Firms with high fixed costs are said to have high operating leverage because small changes in
business conditions may have large impacts on profitability
•In order to quantify the operating leverage:
Degree of operating leverage (DOL)=percentage change in profits/percentage change in sales.
DOL=1+(Fixed costs/profits)
3. Financial Leverage
•The use of borrowing. (Total debt/total equity)
•The interest payments on debt is a fixed costs and Increase the sensitivity of the firms to the
changes in the business cycle.
•Sector Rotation
Portfolio is adjusted by selecting companies that should perform well for the stage of the
business cycle.
Peaks –the economy might be overheated with high inflation and interest rates
–Time to invest in natural resource extraction firms, minerals and petroleum