M ACROECONOMY AND S TOCKS Portfolio Management Ali Nejadmalayeri

Active vs. Passive Factors in Return: 1.Market 2.Industry Growth Cyclical Stable Energy 3.Individual Factors in Risk: Beta or Market Risk Extramarket Covariance or Industry Risk Residual or Specific Active ManagementPassive Management

Active Strategies Market Timing: –Set strategies based on “Market” movement Selective vs. Diversification: –Able to find “gems” or simply hedge risk Group Rotation: –Shift between overrepresented (over-bought) and underrepresented (over-sold) industries or group, e.g., shifting from growth to value at the end of 1999

Group Rotation In equilibrium each sectors represents certain percentage of the total market cap. The proportion of the value of these sectors to other sectors, however, changes thru time. If the proportion is mean reverting, i.e., hovers around some long-run average, then when one sectors gets overloaded, it ought to come down and vice versa. –ETFs based strategies –Services provided for rotating the sectors

Sector Rotation This chart is based on Sam Stovall's S&P's Guide to Sector Rotation and states that different sectors are stronger at different points in the economic cycle.S&P's Guide to Sector Rotation

Economic Indicators  GNP gap:  GNP   E (R M )   Interest rate change  Tbill   E (R M )  Var (R M )   growth in money supply  M1   E (R M )  Var (R M )   Inflation  CPI   E (R M )  Var (R M )   Others: Liquidity, P/E ratio, Housing, etc. From Flannery and Protopapadakis (2002) Review of Financial Studies

Economic Indicators Leading, Lagging, and CoincidentalLeading, Lagging, and Coincidental Traditional Leading Indicator:Traditional Leading Indicator: –The average manufacturing-worker workweek (from the employment report) –Initial jobless claims –Manufacturers' new orders for consumer goods and materials (from the factory orders report) –Vendor performance (from the Purchasing Managers' Index report) –Manufacturers' new orders for nondefense capital goods (from the factory orders report) –Building permits (from the housing starts report) –The level of the S&P 500 –The inflation-adjusted measure of the M2 money supply –The interest-rate spread between the 10-year Treasury note and the fed funds rate –The expectations portion of the University of Michigan's Consumer Sentiment Index

Why Macroeconomy? Consumer consumption (70% of GDP)Consumer consumption (70% of GDP) –Nondurable goods 29% Food, clothing, gasoline, drugs, cleaning supplies,... –Durable goods 12% Motor vehicles, furniture, sporting, tools, books, … –Services 59% Housing, medical, education, transport, recreation, finance, … Government Spending (19% of GDP)Government Spending (19% of GDP) Capital Spending (16% of GDP)Capital Spending (16% of GDP) –Equipment and Software 50% –Residential structures 35% –Nonresidential structure 15%

Cause and Effects Courtesy of

Obsession with “R” Word Courtesy of

Consumption & Productivity Courtesy of

Productivity & Cap Spending Courtesy of

Consumption & Cap Spending Courtesy of

Consumption, Earnings & Stocks Courtesy of