When top-down, bottom up-preferred, tricky

CFA Level III
#1

Hi everyone,

Just a quick question here, would appreciate some input from all you smart people here :slight_smile:

The Economic Analysis book (reading 16 equity market valuation), P144, it says that:

  • If companies react slowly to changes in economic conditions, top-down forecasting is preferred

And…

  • If the economy is on the brink of a change, bottom-up is preferred

Can someone please explain the logic here? Thanks a lot.

#2

Top down approach is better heading into a recession, and bottom-up is better heading into an economic boom.

This is what it means pretty much.

#3

For the second one:

  • If the economy is on the brink of a change, bottom-up is preferred

I’m thinking, the economy is on a brink of a change meaning upturn or downturn, in which case it is better to forecast company prospects based on their products = bottom-up

#4

Companies are quick to react to business pickup by stocking up on inventory at lower costs, and are slow to cut inventory on slower business prospects.

Top-down is the more realistic approach to both, bottom-up is biased towards booming activity in perpetuity, reality is irrational sharp booms and busts. Therefore, top-down for predicting recessions is better than bottom up, botttom up is better for predicting upturns.

#5

Bottom Up - Pro: quicker at detecting cyclical turns in the economy because they have the availabilty of production/inventory data. Con: Managerial optimism/emotional input of firm’s future

Top Down - Pro: smoother forecasts with less noise from volatility. Con: slower at detecting cyclical turns because relies on econometric and gathered data

#6

Thanks to everyone for their help

#7

Very good here.