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On the world's financial markets and stock exchanges. Part 4

The main objective of this lecture is to learn how to use fundamental analysis to determine the current market situation and to identify probabilistic changes.

1. Fundamental analysis of financial markets.

Fundamental analysis studies the current economic trends (macro-economic factors), evaluates the investment climate of a country and calculates the efficiency of investments.
Factors of fundamental analysis determine the dynamics of securities and currency rates in the long-term outlook. Fundamental analysis helps to identify a major market trend. Corporate investors making long-term investments pay much attention to this type of analysis in their forecasts. Fundamental analysis is an analysis that influences the value of a financial asset in terms of macroeconomic, political, military and natural factors. It is designed to answer the question of what asset it makes sense to buy or sell over the long term. Within the framework of this analysis we study messages about financial and monetary events in the world, phenomena of political and economic life of separate countries and the world community on the whole that can influence development of financial markets. 
The fundamental analysis of the financial market is one of the most difficult methods of analysis as the same factors have different influence in different conditions and can change from being decisive to being insignificant. Depending on the financial market segment, each type of analysis has its own characteristics, but in general, fundamental factors are usually evaluated from two points of view 
In terms of the impact on the official discount rate of the Central Bank; 
From the point of view of the state of the national economy. 
 Fundamental analysis distinguishes four groups of factors influencing the market: 

  • economic;
  • political;
  • natural;
  • Military.

2. basic concepts and definitions.

What is economics? The term "economy" and "economics" come from the amalgamation of the Greek words "oikos" - house, household and "nomos" - rule, law. So, economics is the management of the household, the rules of doing business. And the science of economics is the science of the laws of economic development. Economic growth is an increase in the ability of a national economy to produce a product that satisfies the needs of people. The key to economic growth is investment, which must exceed depreciation.

Economic growth is measured in two ways:  

  • as an increase in real GDP over a given period;
  • as an increase in GNI per capita over a given period.

It is measured by the annual growth rate as a percentage. 

Types of economic growth: 

  • Extensive (expansion of production),
  • intensive (application of efficient means of production)

 The market economy is characterised by periods of predominantly extensive and predominantly intensive types of economic growth. This alternation is based above all on the cyclical nature of economic movement, i.e. continuous fluctuations of the market economy, when production growth is replaced by a decline and an increase in business activity by a decline. The cycle is a constant dynamic characteristic of the market economy. 
The economic cycle is a form of movement and development in the market economy. There are different kinds of cycles: 3-4 years (Kitchin cycles), 10 years (Marx cycles), 15-20 years (Kuznets cycles), 40-60 years (Kondratieff cycles). The economic cycle is based on periodic economic crises. The movement of production from one economic crisis to the beginning of another is an economic cycle. It includes 4 phases: crisis, depression, recovery and rebound. The first phase contains the basic features of the cycle. The crisis ends one period of development and begins a new one. Without crisis there would be no cycle, and the periodic repetition of crisis gives the market economy a cyclical character. The crisis develops during the phases of recovery and growth (people have too much money and eventually overproduction occurs). The crisis is followed by a depression phase. The crisis creates conditions for the intensification of the economy. During the depression, these conditions are fixed and a period of intensive development begins, which covers the next phase, the recovery phase. At the end of the recovery phase the stimulus for renewal is exhausted again. And the next phase of the cycle - recovery - again begins extensive development. The reason for the cyclical nature of economic development lies in the conflict between the conditions of production and the conditions of realization, in the contradiction between production seeking to expand and the growth of effective demand not keeping pace with it. The main task of the economy is to smooth out abrupt changes in economic development. It is as unprofitable to have a fall as it is to have a growth spurt. 
When the economy starts to grow sharply, then unemployment falls as a consequence, which causes wages to rise. Then prices start to rise and cause inflation to rise! Increased inflation destroys the economy of a nation and can get out of control and lead to a crisis. Next, we will look at each factor separately.
 The unemployed are citizens who are able and willing to work, to have a job that entitles them to an income. The unemployed do not include people who are not able to work. Those who are capable of work but do not apply for a job are not included. There is total or partial unemployment. The main cause of unemployment is when workers refuse to work for less pay. But Marx emphasised the involuntary nature of unemployment. The demand for labour decreases relatively, and if the value of capital remains unchanged, it decreases absolutely. An increase in productivity drives out workers if there is no increase in the value of capital. Apart from this, the causes of unemployment are the excessive work of one part of the working class, which liberates another part of it, putting it into the ranks of the unemployed. 

Forms of unemployment: 

  • frictional (caused by imperfections in the technical functioning of labour, lack of information about the availability of jobs and other technical reasons);
  • structural (caused by the lack of one or another material resource, by the impossibility of finding a job due to some peculiarities);
  • Technological (caused by the replacement of people by machines)
  • latent (characteristic for agriculture where surplus labour is used in production that actually requires less labour force)
  • Seasonal (caused by fluctuations in production in certain industries depending on the time of year)
  • cyclical (caused by fluctuations in the volume of GNP).

Inflation is the reduction in the purchasing power of money, its depreciation and the resulting increase in the general price level. Demand-pull inflation occurs when the resource utilisation rate is higher than optimal. An excess of demand over supply in full employment leads to an increase in prices.
There are three main forces leading to imbalances in the national economy and inflation: 

  • State monopoly on the issue of paper money, on foreign trade, on non-productive (military, etc.) expenditure;
  • a trade union monopoly that sets the size and duration of a given wage level;
  • the monopoly of the largest firms in determining costs and prices.

 Open inflation is manifested in rising prices. Suppressed inflation is characterised by the fact that prices and wages are tightly controlled by the state, and its main form of expression is general shortages of goods. Inflation can be of several types:
 moderate inflation (less than 10% per year)
 galloping inflation (hundreds of % per year)
 Balanced inflation (prices of different commodities do not change in relation to one another) and unbalanced inflation
Predictable (predictable) and unexpected inflation. 
Inflation has a mixed effect on an economy. Moderate price increases can stimulate production, because wages tend to lag behind price increases. Hyperinflation causes a "flight from money" (barter exchange, etc.). Inflation is connected to a government budget deficit.
 The budget is a list of government revenues and expenditures for a set period of time, which is approved by law. The state budget is the largest centralised fund of money, which is accumulated through the redistribution of national income and is spent by the state to carry out its functions.

The budget can be financed in two ways:

  • the government borrows money from the private sector by selling bonds;
  • the government resorts to the help of the printing press.

Budgeting is based on adherence to certain principles that were developed by developed countries in the early twentieth century:

  • The principle of unity - concentrating in the budget all expenditures and all revenues of the state. A state must have a single budget system, uniformity of financial documents and budget classification.
  • The principle of completeness means that for each budget item all expenditures and all revenues are accounted for.
  • The principle of reality implies a truthful reflection of the state's revenues and expenditures.
  • The principle of publicity means that the population must be informed about the main expenditures and sources of revenue.

Balance of the budget means equality of revenue and expenditure. If budget expenditure exceeds revenue, there is a budget deficit. The revenue side of the budget is mainly made up of taxes. 
The budget system has three functions: 

  • Fiscal function means the creation of a financial basis for the functioning of the state in the actual absence of its own revenues;
  • An economic regulatory function is the use of taxes by the state to pursue its economic policy;
  • The social function is the use of the state budget to redistribute national income.

One of the sources of financing of state activities is government borrowing and money emission. The budget deficit is the amount by which, in a given year, budget expenditure exceeds budget revenue. 
There are several reasons for budget deficits: 

  • a decline in social production;
  • a rise in the marginal cost of social production;
  • a massive issue of "empty" money;
  • unjustifiably "inflated" social programs;
  • increased expenditures for financing the military-industrial complex;
  • large-scale circulation of "shadow" capital;
  • huge unproductive expenditures, embezzlement, theft, etc.

The budget deficit is covered by either increased taxation or government borrowing. One of the main influences of the state on the economy is monetary policy. It is based on the activities of banks. State monetary policy is carried out by the central bank. Its main function is to create an environment in which the credit system is sustainable and functions effectively in the interests of economic growth. The main directions of state monetary policy are: 
changes in the central bank's discount rate;
 changing the required reserves ratio; and open market operations. Changing the discount rate is aimed at changing the amount of lending by private banks and the central bank. Its meaning is that by changing the level of the interest rate on loans to private banks, the central bank thereby limits the credit expansion of private banks, because if the lending capacity of private banks is limited, then the credit of the private banks themselves is also limited. The government raises interest rates during periods of rapid economic growth in order to reduce the overheating of the economy. Making credit more expensive and restricting the flow of money into the credit system is called "hard money" policy. 

The main government organisations that are responsible for changing the interest rate: 

  • US Federal Reserve (FED) The Federal Reserve Committee (FOMC) meets 8 times a year at 22-15 Moscow time, the current rate is 5.25%.
  • Europe European Bank(ECB) meets every 2 weeks on Thursdays at 15-45 MSK. Has not changed for 3 years, then it went up from 2.25% to 3.75%.
  • Bank of England (BOE or "Old lady") meets once a month at 15-00 Moscow time and the current rate is 5.25%.
  • Switzerland Bank of Switzerland (SNB) floating rate 1.25-2.25%
  • Japan Bank of Japan(B0J) . At one time the rate was 0.002%, now it is 0.25%.

An increase in the interest rate will most often lead to an appreciation of the currency and vice versa. 

3. Economic indicators

Fundamental analysis most often deals not with absolute values, but with indices, as it is not the absolute value of the indicator, but the speed of its change, which is more important for the economy. Index information is usually presented as a percentage. The economic calendars on the websites of financial companies can be found on our website. There you can find the exact date and time of the indicator's release, as well as its past value and forecast. 

  • Leading economic indicators
  • Employment report
  • Gross Domestic Product
  • Consumer price index
  • Producer price index
  • Purchasing Managers Index
  • Consumer Confidence Index
  • Durable Goods Orders
  • Commercial inventories
  • Construction Expenditures
  • Employment Expenditures Index
  • Consumer Credit
  • Sales of new homes
  • Secondary market housing sales
  • Industrial orders
  • Number of dwellings under construction
  • Number of job applications from unemployed persons
  • Number of job advertisements
  • Industrial production
  • Individual Income and Consumption
  • Retail Sales
  • Atlanta Fed index
  • Chicago Purchasing Office Index
  • Philadelphia Fed Index

Leading Economic Indicators A composite index comprising 10 economic indicators (1996=100) that are ahead of the trend of business activity with a time lag of six to nine months. These indicators include:

  • Average working week (from the employment report)
  • Number of initial jobless claims Volume of orders for consumer goods (from the Industrial Orders report)
  • Supplier evaluation (from the National Association of Purchasing Managers report)
  • Volume of non-defence industrial goods orders (from industrial orders report)
  • New building permits (from New Construction Report)
  • S&P 500 index level
  • Inflation-adjusted M2 monetary aggregate
  • Spread between 10-year Treasury bond and federal funds interest rates
  • University of Michigan Consumer Sentiment Index

The report is published monthly (end of month at 10:00 am) by the National Industry Association and contains data for the previous month. It does not have a noticeable impact on the trading dynamics.

Employment Report 
 The report reflects the labour market situation and contains data on employment rates, number of new jobs, average hourly earnings, and the length of the average workweek. 
It is published monthly on the first Friday of every month at 8:30 a.m. by the Bureau of Labor Statistics and contains data for the previous month.
It has a large impact on the trading dynamics, as it is considered as the most accurate indicator of economic conditions. 
Gross Domestic Product
 A measure of changes in the market value of goods and services within a country over a certain period of time. Published quarterly (at 8:30) by the Ministry of Commerce. On the last working day of January, April and October preliminary data are published for the previous quarter. One month later, adjusted figures are published. One month later there is a final report with final GDP figures. 
Highly influenced by the trading dynamics
 Note: 1) Individual consumption expenditures usually account for about 68% of GDP. Investment and government spending as well as net exports account for the remainder. 2) The GDP deflator, an index for converting nominal prices to real prices, is also reported.
 
Consumer Price Index 
A measure of the change in the cost of a basket of goods and services (food, clothing, electricity, housing and vehicle maintenance, medical care, recreation and education). Reference period: 1982-84 = 100. Published monthly (usually on the 15th of the month at 8:30) by the Bureau of Labor Statistics, it contains data for the previous month.
  It has a high impact on trading dynamics
Note: The core consumer price index, which reveals trends in implicit inflation, is calculated without taking into account volatile food and energy prices.
Producer Price Index 
The Producer Price Index (1982 = 100) measures the change in wholesale prices at which producers sell their products in all stages of production (raw materials, semi-finished and finished products). It is published monthly (at 8:30 a.m. on or around the 13th ) by the Ministry of Labour and includes data for the previous month.
 It has a high impact on trading dynamics
Note: The Producer Price Index is a core indicator that measures the underlying inflationary trend and excludes volatile food and energy prices.
 
National Association of Purchasing Managers' Index 
Based on a survey of purchasing managers in some 300 industrial companies, the Purchasing Managers' Index indicates the state of the business climate. A score above 50 indicates a recovery in economic activity. A score below 50 indicates deteriorating economic conditions.
 It is published monthly (on the first business day of the month at 10:00 am) by the National Association of Purchasing Managers and includes data for the previous month. 
It has a high impact on trading dynamics
The index is considered as one of the most accurate indicators of the current state of the industrial sector. 
Note: The NPA Purchasing Managers Index comprises nine sub-indices: new orders, production, employment, shipments, inventories, prices, new export orders, imports, and backlogs. These sub-indices are used to forecast
These sub-indices are used for forecasting industrial output, producer price index, industrial orders, industrial employment and for the calculation of leading economic indicators.Consumer Confidence Index 
The Consumer Confidence Index (1985=100) is based on a randomly selected survey of 5,000 households, and measures consumer attitudes to current economic conditions, labour market conditions, career prospects and income growth. It is published monthly (last Tuesday of the month at 10:00 am) by the National Industry Association and contains data for the previous month.
 Normally it does not have a significant impact on the trading dynamics.
 
Durable Goods Orders 
The volume of orders received by manufacturers for Durable Goods.  It is published monthly (usually on the 26th at 8:30) by the Census Bureau and contains data for the previous month.
 It has a high impact on trading dynamics.
Note: Some data from the Durable Goods Orders report is used to forecast the business investment component of GDP and to calculate the index of leading economic indicators. Most important is the percentage change from the previous month, but the year-on-year change is also taken into account.
 
Business Inventories 
Inventories formed in the production stages, wholesale and retail sales. It is published monthly (usually on the 13th at 8:30) by the Census Bureau and contains data for the previous two months.
 It has no discernable impact on trading dynamics. 
Note: The report shows the percentage change in commercial stocks compared to the previous month and provides data on the year-on-year change in stock levels.
 
Construction Spending 
A measure of the value of new private (including residential and non-residential) and municipal construction. Published monthly (on the first working day of the month at 10:00 a.m.) by the Census Bureau and contains data for the previous two months.
 Does not have a noticeable impact on the tendering dynamics. 
Note: The municipal construction indicator is used in forecasting the percentage of public expenditure in GDP. The indicator for residential and non-residential construction is used to determine the percentage share of investment in GDP. The most important is the percentage change from the previous month, but the year-on-year change is also taken into account. 
Employment Cost Index 
The index (1989 = 100) measures the change in labour costs excluding the migration of workers from one industry to another. Published quarterly (on the last working day of January, April, July and October at 8:30 E.T.) by the Ministry of Labour and contains data for the previous quarter.
  It is considered as one of the most important leading indicators of inflation.
 Note: The most important is the percentage change compared to the previous month, although the year-on-year change is also taken into account.
 
Consumer Credit 
It is a statistical report released by the Federal Reserve Board that shows changes in levels of credit to the public for purchase of consumer goods or services. It is published monthly (on the fifth business day of the month at 15:00) by the Fed and contains data for the previous two months.
It does not have a significant impact on the trading dynamics.
 
New Home Sales 
An indicator of the volume of sales of new residential single-family buildings. Includes a geographical breakdown as well as a measure of residential building prices and inventory (the number of months it takes to deplete the existing inventory of new residential buildings at the current sales rate). Published monthly (at the end of the month or at the beginning of the next month at 10:00 am) by the Census Bureau and contains data for the past month. 
Occasionally has some impact on the bidding dynamics. Note: New residential constructions account for 16% of all residential constructions sold. The remaining 84% is made up of secondary market housing sales.
 
Existing Home Sales An indicator measuring the level of sales in the secondary property market. Includes a geographical breakdown as well as a price and inventory indicator (the number of months it takes to exhaust the existing inventory of homes in the secondary market at the current sales rate). Published monthly (usually on the 25th at 10:00 am) by the National Association of Realtors and contains data for the past month.
 In some cases, it has some impact on the trading dynamics.Note: Secondary market housing sales account for around 84% of all residential property sales; the remaining 16% is accounted for by new residential buildings.
 
Industrial Orders (Factory Orders) 
The indicator of orders, deliveries (sales) and inventory at the factory level.  Published monthly (the first week of the month at 8:30) by the Census Bureau and contains data for the previous two months.
It does not have a significant impact on the trading dynamics.
 
The number of housing starts (Housing Starts) 
The indicator, calculated on the basis of geographical sample, includes the number of private dwellings under construction and the number of houses for which construction permits have been issued. The report is published monthly (usually on the 18th at 8:30am) by the Census Bureau and contains data for the previous month. 
On occasion, it has some impact on the trading dynamics. Note: Construction of new residential buildings usually starts three to four months after obtaining a permit from the authorities. Permits for new construction are a component of the leading economic indicator index. Construction of single-family homes accounts for about 74% of all new residential construction, with multifamily construction accounting for the remaining percentage. The indicator is used to project the percentage of housing investment in GDP.
 
Initial Claims 
The indicator shows the number of people who have made initial claims for state unemployment benefits.  The report is published weekly (Thursday at 8:30) by the Ministry of Labour and contains data for the week ending before the previous Saturday. 
On rare occasions it has some impact on the trading dynamics. Note: The moving average of the past four weeks is used to detect underlying trends in the labor market. It is considered an effective indicator of labour market conditions and a reliable indicator of future trends in the employment report. 
Number of job offers (Help-Wanted Index) 
The index (1987 = 100) shows the number of job offers from 51 newspapers published nationwide.  The report is published monthly (the last Thursday of the month at 10 ) and contains data for the previous month. 
It does not have any impact on the trading dynamics. 
Note: It is used when forecasting trends in the labour market, based on the assumption that more (fewer) advertisements at the moment means more (fewer) jobs in the future. However, the recent increased role of the internet has likely reduced the reliability of this index.
 
Industrial Production 
A statistical report released by the Fed, which measures the change in the overall output of industrial production by the country's industries. Includes a measure of capacity utilisation.  It is published monthly (usually on the 15th day at 9:15) by the Fed and contains data for the previous month.
It has a high impact on the dynamics of trading
Note: Of main interest is the percentage change compared to the previous month, and the capacity utilization. It is considered as a key indicator of industrial conditions. 
Personal Income and Consumption A measure of changes in personal income and expenditures. It is released monthly (on the first business day of the month at 8:30) by the Ministry of Commerce and contains data for the previous two months. 
It has no discernable effect on the trading dynamics. 
Note: The report also includes an indicator of the individual savings rate. The importance of this report has increased somewhat since the Federal Open Market Committee began forecasting inflation on the basis of the rate of personal consumption expenditures in February 2000.
 
Retail Sales 
A measure of changes in retail sales. It is released monthly (usually on the 12th day at 8:30 am) by the Census Bureau and includes data of the previous month. 
It has a high impact on trade dynamics.
Note: Most important is the percentage change from the previous month. It is used in forecasting private consumption expenditure.
 
APICS Business Outlook Index 
An index based on a survey of industrial enterprises, which signals an increase in economic activity if its value exceeds 50 and a decline if the value falls below that level.  It is published monthly (on the last business Wednesday, Thursday or Friday of each month (the last of those days) at 8:30) and contains data for the current month.
 It does not have a significant impact on the trading dynamics.
Note: Used when forecasting the Purchasing Managers' Association index, which is published a few days later.

Atlanta Fed Index 
A regional survey of industrial enterprises (Georgia, Alabama, Florida, Tennessee, and Louisiana). The index signals an increase in economic activity if its value is above zero, and a decrease if the value is negative.  It is released monthly (usually on the 12th day at 9:00) by the Federal Reserve Bank of Atlanta and contains data for the previous month. 
It has practically no effect on the trading dynamics.
Chicago Purchasing Managers' Index 
An index of industrial enterprises in the Chicago region. It signals about the growth of economic activity in the region if its value exceeds 50 and about decline if the value falls below that level. It is released monthly (on the last business day of the month at 10:00) by the Chicago Chapter of the National Association of Purchasing Managers and contains data for the previous month. 
It has a sufficiently high impact on the dynamics of trading
It is used along with the Philadelphia Fed Index in forecasting the National Association of Purchasing Managers' Index, which comes out a few days later.
Philadelphia Fed Index 
An index of general economic conditions in the region (Pennsylvania, New Jersey and Delaware). The index signals about the growth of economic activity in the region, if its value is above zero, and about the decline, if the value is negative. It is released monthly (usually on the 18th day at 10:00) by the Federal Reserve Bank of Atlanta and contains data for the current month.
It has a fairly high impact on trading dynamics
 Along with the Chicago Purchasing Authority Index, it is used in forecasting the National Association of Purchasing Managers' Index, which is released a few days later.

 

 

 

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