Fundamental Analysis2018-08-30T12:50:02+00:00

Fundamental Analysis

Professional traders, investors and money managers carry out fundamental analysis on the strengths and weaknesses of a particular economy and or region and its impact on the capital markets and different financial assets to assess whether a particular financial asset or product might appreciate (rise) or depreciate (fall) in the future. Through Sandton Capital Markets trading platforms, a trader can access multiple tools and resources to help them analyze their market or financial asset of choice, including Equity Indices, Currency pairs, and Commodities.

What is fundamental analysis?

Unlike technical analysis, which looks purely at price action and trends, fundamental analysis takes on a much more rigorous assessment of financial assets and valuation, such as an Equity Index, a Commodity and or a currency. Looking particularly at the Currency markets, fundamental analysts look at key elements that are likely to have a bearing on the strength or weakness of a distinct currency, such as economic data, and political factors with in a country or a region versus other countries and or regions.

Economic indicators are used by economists, financial analysts, money managers & financial advisers, Investors and to understand how the economic activity is currently progressing, where it has been and more importantly where it might be heading. The Economic reports calendar can be broken down in to 2 categories, Leading and Lagging (Coincident). These two kinds of economic data reports are designed to help investors and traders globally understand the current economic situation and development in the near future.

  • Lagging and Coincident indicators can be viewed as one group of economic indicators that reflect a particular economy’s or a region current and past (Rear view mirror) performance. The changes to these indicators are only identifiable after an economic trend or pattern has already been established.
  • Leading economic indicators at times have a much higher impact on financial markets and valuations. They often change prior to economic adjustments, shifts and cycles and, as such, can be used to predict the future trends.


Key factors of fundamental analysis

Economic growth and output
The key indicator of economic growth is Gross Domestic Product (GDP), which calculates the sum of goods and services produced within the country or region. It’s one of the most important indicators of economic growth and output, which tells us about the economic strength and performance of a country or a region. The GDP report is considered a lagging indicator.

Unemployment Rate
The Unemployment Rate is a measure of the individuals who are currently unemployed with in a country or region and it is calculated as a percentage of the total work force within an economy.  The number of the unemployed individuals is divided by all the employed persons currently in the labor force. During periods of slow down, an economy usually experiences a rising unemployment rate versus periods of economic expansion where there is a rise in job participation rate and a fall in unemployment.
In the U.S since the financial crisis in 2008 the Nonfarm Payrolls the NFP has become highly important gauge for the health and growth of the economy. The NFP is a term used in the U.S. to refer to any job with the exception of certain sections of the workforce (Excluded employed persons are: farm works, unincorporated self-employment, and employment by private households, the military and intelligence agencies. Proprietors are also excluded). The U.S. Bureau of Labor Statistics the BLS releases closely-followed monthly data (Usually the 1st Friday of the month) on nonfarm payrolls as part of its Employment Situation Report. The headline figure, the change in the total number of nonfarm payrolls compared to the previous month, is used as a gauge of economic health and growth of the U.S. The unemployment report is considered a lagging indicator.

Inflation (Changes in prices of goods and services) 
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
The Personal consumption expenditures (PCE) in the U.S is the primary measure of consumer spending on goods and services in the U.S. economy. It accounts for about two-thirds of domestic final spending, and thus it is the primary engine that drives future economic growth and inflation.
The Producer Price index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.

Interest rates
Interest rates have a direct and important impact on an economy or a region. All aspects of the capital markets and assets are directly impacted by Interest rates. One of the primary currency valuation and rates are interest rates. The demand for a particular currency with a higher yielding interest rate (With a similar global ranking and or rating) is often greater than the one with a lower interest rate. Professional asset managers occasionally use the interest rate differentials among various currencies to establish a Carry Trade.
Carry trade is a strategy in which an investor or a trader borrows money at a low interest rate in order to invest or trade in an asset that is likely to provide a higher return (Higher interest rate – rate differentials). This strategy is very common in the foreign exchange markets. An example: buying the Australian dollar AUD for its higher interest rate of 2 percent and selling a much lower paying interest paying currency like Japanese Yen with 0.10 percent. 

Retail Sales Report
The Retail sales report acts as leading indicator in that an increase often precede higher CPI numbers, and a decrease raises the specter of a slowing consumer expenditure and economic activity. The data is highly detailed; investors can look at specific industries in which they hold positions. The figures vary widely from month to month.

The Housing Market
The rise or decline in housing prices, building activity (New requests for building permits) and sales of new and existing homes has a direct impact on the economy for several key reasons:

  • Decrease or increase in homeownership and wealth.
  • An increase or reduction of the number of construction jobs and materials needed to build new homes and to renovate, which thereby has a direct impact on unemployment.
  • They might affect property taxes, which expands or limits government resources.
  • Homeowners will be able or less inclined to refinance or sell their homes.

When fundamental analysts observe the housing data, they look at two things: changes in housing values and the increase or decline in sales both new and existing.

The Equity (Stock) Market
Though the equity (Stocks or shares) market valuation is not the most important indicator, it’s the one that most people look to first. Because stock prices are based in part on what companies in a particular economy or region are expected to earn, the market can indicate the economy’s direction if earnings estimates are accurate. For example, a strong market may suggest that earnings estimates are up and therefore that the overall economy is preparing to thrive. Conversely, a down market may indicate that company earnings are expected to decrease and that the economy is slowing.  The stock market is also susceptible to the creation of false positives and over-reaction (Euphoria or Panic) regarding the market’s direction.

Inventory Levels
Inventory levels are a leading indicator. High Inventory levels can reflect two very different scenarios: either that demand for inventory is expected to increase or that there is a current lack of demand. In the first scenario, businesses are optimistic and purposely bulk up inventory to prepare for increased consumption in the coming months. If consumer activity increases as expected, businesses with high inventory can meet the demand and thereby increase their profit. Both are good things for the economy. In the second scenario, however, high inventories reflect that company supplies exceed demand. Not only does this cost companies money, but it indicates that there is a lack of confidence and reduction in sales.

Manufacturing, Industrial Production & Capacity utilization Report
The Purchasing Managers’ Index (PMI) is a leading economic indicator for the health and of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment., Industrial production and capacity utilization indicate not only trends in the manufacturing sector, but also whether resource utilization is strained enough to forebode inflation. Also, industrial and manufacturing production is an important measure of current output for the economy and helps to define turning points in the business cycle (Slowing of economic activity and or start of recovery cycle).
The U.S ISM manufacturing index is based on surveys of 400 purchasing managers regarding manufacturing in 20 industries. The main components of the index are seasonally adjusted for variations within the year, differences due to holidays, and institutional changes. Financial markets are highly sensitive to changes in this index, as it is one of the first pieces of economic data released each month in the U.S. Also, because the ISM survey is a diffusion index, it measures the breadth of change across manufacturing. This makes it useful in gauging the economy’s momentum, and it is a leading indicator for the GDP.

Non-manufacturing (Services Report)
The service sector produces intangible goods, more precisely services instead of manufactured goods; it is comprised of various service industries including warehousing, transportation, information technology, financial and banking services, etc. Countries with economies centered on the service sector are considered more advanced than industrial or agricultural economies. Services report tracks the larger portion of the economic sector (Developed countries). 

Business and Consumer sentiment
Often a leading indicator designed to show how a group feels about the economy, financial markets, business environment or consumers perception of near future prospects and performance. A sentiment indicator seeks to quantify how various factors, such as unemploymentinflation, macroeconomic conditions or politics influence future behavior. Sentiment indicators can be used by investors to see how optimistic or pessimistic people are to current market conditions. For example, a consumer sentiment index that shows pessimism may make companies less likely to stock up on inventory, because they may fear that consumers will not spend. 

Trade Balance
The balance of trade (BOT) is the difference between a country’s and or a region’s imports minus its exports for a given time period. The balance of trade is the largest component of the country’s balance of payments (BOP). As the demand for goods and services from a particular country increases, demand for the country’s currency may also go up.

Political situation
Political crisis and uncertainty in a country or a region often have a negative impact on the demand for their currency or any other financial asset. When a country is politically unstable, investors’ confidence in its economy tends to decrease.  

Fiscal policies
Government policies are referred to as Fiscal policies, such as the budget planning, expenditures, rules and regulations and the highly important tax rates levied by governments. Policies by governments can encourage or discourage productivity and spending in the economy, and therefore have a major impact on the capital markets and can impact the currency markets directly.

Monetary policy
The monetary policy as is set by Central Banks has a very important influence on the near-term demand and valuations for all financial assets including currencies. If, for example, the U.S Federal Reserve Bank the FED, which is the most powerful Central Bank in the world, adopts a hawkish monetary policy, this indicates that interest rates are set to rise and may increase the demand for the U.S dollars, which might lead to the appreciation of the U.S dollar. Hawks generally favor using relatively higher interest rate environment to help keep inflation in check, in contrast to doves or dovish policy is lowering interest rates in order to stimulate economic growth.

Money Supply (M1, M2 and M3)
The Money Supply refers to the entire stock of currency and other liquid instruments in a country’s economy as of a particular time.

  • M1 is a measure of the money supply that includes all physical money, such as coins and notes, demand deposits, checking accounts and Negotiable Order of Withdrawal. M1 measures the most liquid components of the money supply.
  • M2 is a broader money classification than M1. M2 is a measure of money supply that includes all the elements of as well as “near money”. “Near money” refers to savings deposits and other money market instruments such as fixed deposits which are less liquid. They can easily be converted to cash but are not as suitable as mediums of exchange mediums due to their less liquid nature.
  • M3 is a measure of money supply that includes all elements of M2 as well as large time deposits, institutional money market funds, and other larger liquid assets. The M3 measurement includes assets that are considerably less liquid than other components of the money supply. They tend to lean towards assets associated more with larger financial institutions and corporations than to the smaller business units and individuals.

The money supply (Availability of credit) has been closely monitored by economists and central banks globally and is often the centerpiece of monetary policy. Money supply is positively correlated with interest rates. An increase in the supply of money typically lowers interest rates, which in turns generates more investment and puts more money in the hands of consumers, thereby stimulating spending and growth. The expansionary monetary policy also known as quantitative easing has being in recent years implemented extensively by the U.S Federal Reserve, U.K’s Bank of England, the Euro-Zone’s ECB, by Bank of Japan and many other central banks worldwide in an attempt to stimulate growth.

Examples of Leading economic indicators: 

  • The average weekly hours worked by manufacturing workers.
  • The average number of initial applications for unemployment.
  • The amount of manufacturers’ new orders.
  • The speed of delivery of new merchandise to vendors from suppliers.
  • The amount of new orders for capital goods (Non-defense).
  • The amount of new building permits for residential & commercial buildings.
  • Equity (Stock) market.
  • The inflation-adjusted monetary supply (M2) and availability of credit.
  • The spread (Difference) between long and short interest
  • Consumer sentiment.

Natural & Man-made disasters
Natural & Man-made disasters, such as flooding, drought, earthquakes, epidemics & disease, political uncertainties, effect of conflict or war, hurricanes, tsunamis, etc. can have a major impact on the fundamental strength or weakness of an economy and or a region.