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As the economy goes, so goes the stock market; as we've seen in an earlier chapter, the stock market is a leading economic indicator. Good economic insight will help with analyzing the current state and likely future path of the stock market. A number of good Internet sites offer analysis on the market, too. Morgan Stanley's Web site has a link (or enter "global strategy bulletin" in the site's search function) to the Global Strategy Bulletin, which contains an analysis of the U.S. economy and the economies of several other countries. We've seen Edward Yardeni's site in an earlier chapter. Of special relevance to this chapter are the forecasts for the economy, earnings, and stock market, which appear on his site's pages. Information is available concerning the markets in a number of countries. The National Association of Business Economists home page includes links to a number of economic information-related sites and data sources. Links include the Bureau of Economic Analysis (, which contains information about GDP and its compo nents, and the U.S. government's publication, Survey of Current Business. Links to the Bureau of Labor Statistics ( provide data on various measures of inflation, unemployment, and productivity. Other links include the Census Bureau (, Congressional Budget Office (, Council of Economic Advisors ( CEA/html/CEA.html), The Conference Board, publishers of the Index of Leading Economic Indicators (, and links to a number of sources of international data, from both U.S. and overseas statistical agencies. The site contains helpful industry information, too, with links to the U.S. Industrial Outlook, Federal Trade Commission, and a number of industry trade association sites. The home page of A. G. Edwards & Son, Inc., allows visitors to obtain specific research reports on different topics, companies, and stocks. The site contains pages with an analysis of economic trends, both in the U.S. and abroad. A separate site focuses on international perspectives. Web sites of many other brokerage houses will contain market analysis, too.

Summary • We consistently emphasize the importance of analyzing the economies and security markets before analyzing alternative industries or companies. You should determine whether the economic and market outlooks indicate an underweighting or overweighting related to investing in stocks, bonds, or cash before you consider which is the best industry or company.

• There are three techniques available to help you make the market decision. The first are macrotechniques, which are based on the strong relationship between the economy and security markets. These models base their market projections on their outlook for the aggregate economy and certain components. The second are microtechniques, which estimate future market values by applying one of several basic valuation models to equity markets. The third is technical analysis, wherein you analyze past and recent market movements for indications of future performance. In Chapter 12, we examined the macrotechniques and discussed a world asset allocation. This chapter has been devoted to the microanalysis of equity markets in the United States and other countries. In Chapter 16 we will discuss numerous technical analysis tools.

• Our microanalysis of the U.S. equity market considered both approaches to equity analysis—the present value of cash flow techniques and the relative valuation ratio techniques. The cash flow techniques provided a range of estimates, most of which indicated that the market was fully valued, which implies that the rates of return on common stock in the near term will be lower than the long-run historical returns and certainly lower than during 1995-1999.

• We considered four relative valuation ratios, including the earnings multiple (PIE) approach where we discussed a two-step approach that included estimating EPS and the PIE ratio based upon the DDM. As a result, we generated a specific intrinsic market value and the expected rate of return implied by this fundamental market value. The other three ratios (PIBV; PICF; and PIS) were defined and explained in anticipation of using them during industry and company analysis where the relative valuation technique compares an industry to the market and relates a company to both its industry and the aggregate market. The goal is to evaluate the relative value position of an industry or a stock. This initial analysis of the valuation ratios was intended to demonstrate the computations involved and show the consistent, substantial increase in all the ratios during the past 25 years. Subsequent analysis will need to consider what variables drive these relative valuation ratios and evaluate whether these variables have changed in a way that justifies these lofty ratio values.

• Finally, although we applied both sets of valuation techniques to the stock market in the United States, we know it is necessary to do a similar analysis for non-U.S. markets. An example of such an analysis by Goldman Sachs shows how the firm applied the top-down approach to several major countries.

Following this aggregate market analysis, the next step is industry analysis, which is considered in the following chapter.

Questions 1. An investor is convinced that the stock market will experience a substantial increase next year because corporate earnings are expected to rise by at least 12 percent. Do you agree or disagree? Why or why not?

2. Find at least three sources of historical information on nominal and real GDP. Find two sources of an annual estimate of nominal GDP.

3. To arrive at an estimate of the net profit margin, why would you spend time estimating the operating profit margin and work down?

4. You are convinced that capacity utilization next year will decline from 82 percent to about 79 percent. Explain what effect this change will have on the operating profit margin.

5. You see an estimate that hourly wage rates will increase by 6 percent next year. How does this affect your estimate of the operating profit margin? What other information do you need to determine the effect of this wage rate increase and why do you need it?

6. It is estimated that next year hourly wage rates will increase by 7 percent and productivity will increase by 5 percent. What would you expect to happen to unit labor cost? Discuss how this unit labor cost estimate would influence your estimate of the operating profit margin.

7. Assume that each of the following changes is independent (i.e., except for this change, all other factors remain unchanged). In each case, indicate what will happen to the earnings multiplier and explain why.

a. The return on equity increases.

b. The aggregate debt-equity ratio declines.

c. Overall productivity of capital increases.

d. The dividend-payout ratio declines.

8. Briefly discuss the two factors that must be considered (estimated) whether you are employing the present value of cash flow approaches or the relative valuation ratio approaches.

9. Discuss the difference between the constant growth DDM and the two-stage growth model. In your discussion, explain when you would use each of these models.

10. Based upon that data contained in Exhibit 13.27, what would be your estimate of nominal GDP growth for the United Kingdom versus Japan in 2003?

11. Based upon the data in Exhibits 13.27 and 13.29, what is the main reason for the current interest rate in the United States versus Japan?

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