The Practical Guide to Wall Street: Equities and Derivatives

CHAPTER 12

Macroeconomics for Trading and Sales

INTRODUCTION

The price of a stock, and by implication the value of derivatives on that stock, is a complex and highly unstable function of two principal factors:

1. Company-specific characteristics: These are the microeconomic factors that we looked at in the first two chapters on fundamental valuation. (Is the business well run? Do they offer an attractive product?)

2. Broader macroeconomic conditions: While a well-run company offering an attractive product can be expected to produce superior returns to a poorly run company selling a low-quality product, neither company will do well if the economy as a whole goes into a downturn. Individuals will only consume if they have the money and confidence to do so, and high levels of unemployment, rising inflation, and low consumer confidence will negatively impact all companies. Though the impact is by no means equal across all businesses, no matter how appealing the specific characteristics of the company, the broader macroeconomic trend will usually dominate and even the best companies will suffer in a downturn.

As a result to properly understand (or better yet, anticipate) the movements of the equity market, an investor must have at least a general knowledge of the structure and functioning of the economy as a whole.

In the first part of the book, we looked at various methods for analyzing the fundamental characteristics of a particular company in order to determine whether its stock ...