Macro analysis often gets a bad rap these days. Fund managers often prefer to associate themselves with value investors like Warren Buffett, who famously deride the use of macro analysis. However, we can’t all be Warren Buffett, so macro analysis can form an important part of many investment processes.
Using macro analysis doesn’t mean ignoring the bottom-up view, instead, it can be seen as a complimentary form of fundamental analysis. To better understand how the professionals use top-down analysis, we reached out to three leading economists in different areas of investment management to hear how they apply macro to their strategies.
Responses are by Tim Toohey from Ellerston Capital, Nick Bishop from Aberdeen Standard Investments, and Sam Ferraro from Evidente.
The two ‘policy levers’ that drive asset prices
Nick Bishop, Head of Australian Fixed Income, Aberdeen Standard Investments
Investors can use economic analysis in two ways. Firstly, by analysing the performance of macroeconomic data such as GDP growth, inflation and employment, an investor can form a fundamental view of a given target economy. Understanding these fundamentals at a macro level underpins the view on the outlook for monetary and fiscal policy. These two “policy levers” – official cash rates and government spending preferences – have great potential impacts on bond yields, currency levels and risk assets such as equities.
Secondly, statistical analysis of economic data is useful in finding leading (i.e. predictive) relationships between economic and financial data that can help with the asset allocation process, as well as informing positioning within asset classes. We believe markets ultimately reflect fundamentals, so the starting point must be economic analysis.
How top-down can complement bottom-up
Sam Ferraro, Director, Evidente
Most equity portfolio managers in Australia brand themselves as being bottom-up, with a focus on financial accounts, industry structure dynamics, quality of senior management, as well as environmental, social and governance (ESG) risks and how companies are responding to those risks.
The business cycle and related top-down factors outside of the control of corporate insiders – including shifts in the regulatory environment – can have an important influence on company profitability and expected stock returns, particularly for the banks, REITs and mining firms. Top-down factors ought to represent an important input into portfolio construction decisions, particularly around the size of sector bets across these industries.
Awareness of the cycle is essential
There are some individual investment strategies that can function independent of incorporating economic analysis but for anyone charged with the responsibility of managing the strategic and tactical choices between alternative assets then economic analysis is the foundation stone from which most decisions are made. For those of us involved in discretionary macro trading detailed economic analysis is the lifeblood of the strategy.
This is not to say that everyone needs to be following the minutia of the economic dataflow and the vagaries of shifting economic theories. Nevertheless, a keen awareness of where we are in the economic cycle and which asset classes are best placed to perform at that stage of the cycle are essential to investment performance. We believe most of the alpha is captured in the investment process by identifying the turning points in the economic cycle and altering the portfolio strategy appropriately.