Jim Leepresented to

FINA-5340 (Investment Portfolio Theory)

September 19, 2011

OverviewWhy economic fundamentals

and forecasts are important for investment

What and where to look for information

Brief survey of “how they do that”

What should you (the investor) make of all the data

Takeaway

Why Economic Fundamentals and Forecasts are Important for InvestmentMost businesses are affected by the overall

economic conditions in the economy (taken as given)

And so are financial markets and financial instruments (stocks, bonds, loans etc.)

A basic understanding of the current and future macroeconomic performance will help you make more informed investment decisions about companies and their obligations

For speculative activities: Try technical trading!

Where to look for data/informationInvestors should keep abreast of the current

economyA typical day in the office should begin with a brief

review of news on the economy (after a quick look at the “markets”)

If you are a professional, you should already have subscriptions to news alerts from the business media:Financial TimesWall Street JournalFortune/BloombergUpdates from major financial institutions

Or, get it for free…

What to look forNot all “indicators” are created the same:

Some are leading, some are lagging Markets react mostly to news releases

(surprises) of leading indicators (unemployment claims, consumer confidence, manufacturers’ new orders, PPI)

The Conference Board’s Index of Leading Indicators is the most popular outlook indicator

How do they do thatFirst ECON course gives you a comprehensive

understanding of basic macroeconomic concepts (GDP, CPI, employment, etc)

Forecasting Methods:Indicators (leading and lagging)Surveys of economists & professionalsStructural Models (CBO, FRB)Time-series modeling

Extrapolation ARIMA, ARCH/GARCH

They are right almost 50% of the time

What to look for (in a typical outlook presentation)

Global economic conditionsNational economic conditions

Economic indicators/statisticsFed watching

Regional conditionsExample: Dallas Fed indicators

Developments in industries/sectorsExample: Oil, housing, real estate

Local conditions (market conditions) by experts

What To Make of All the DataPerhaps nothing at all!The efficient market hypothesis implies that

the markets will (almost) immediately respond to all publicly available information.

… unless you see things that are different from the consensus, i.e., surprises.

For day traders: Try to stay ahead of everyone else, rather than waiting to be informed.

For Warren Buffett-type long-term investors : Trends are persistent, the hardest part is to spot the business cycle turning point

Pop Quiz: What can you make of this?The Dow is highly correlated with GDP…

What If I Choose to Ignore the Economy? “It’s the economy, stupid!”—a true story

Thank y’aw !%*#