Macro explanations don't hold water in small caps (and these stocks prove it)

Macro theses can only take you so far.
David Thornton

Livewire Markets

Markets have been drowned out by the macro - be it inflation, rates, geopolitics, the labour market, government and corporate debt, or the myriad of other factors you'll see discussed.  

The corollary is that stock analysis too often boils down to macro conclusions. Even when analysis is done using bottom up fundamental analysis, the outcomes are often tied back to macro. 

There's nothing wrong with this (and often these conclusions can be valid). But what explains the dispersions between stocks within sectors? Filling this gap is the key to achieving alpha through the cycle, especially when volatility is high. 

At the latest Pinnacle Insights LIVE 2023 Australian Equities event, David Wanis, a portfolio manager at Longwave Capital, demonstrated the benefit of looking past the macro to understand company performance. 

As he explains, macro can explain sectors but it doesn't do a very good job of explaining dispersions within sectors. This wire is a summary of that argument (with some stock examples to boot). 

Insights you won't get from macro

"We don't take a top-down view to sector allocations, we think of bottom-up, and in small caps that's really important," says Wanis. 

If sector distributions were tight, then macro explanations hold a lot of water. But when there's a lot of daylight between the earnings forecasts of different companies within the same sector, macro explanations fall apart.  

"The problem with small caps is that the dispersion of how the companies perform far outweighs any of those macro influences."

The sector EPS estimates below show this to be the case. 

"Coming into the back half of last year, a lot investors would've questioned why you'd buy consumer discretionary stocks. Rates are going up, so the common view is that retail will suffer as a result.

Source: Bloomberg Consensus EPS estimates: Jun 2022 to Feb 2023

"So the performance of Lovisa (ASX: LOVand Accent (ASX: AX1relative to the performance of Baby Bunting, BWX and Kogan had nothing to do with what the RBA was doing. It was mostly down to how company managing were executing and delivering earnings growth to their shareholders."

Not convinced? Let's bring a classic defensive play into the fold - healthcare. 

"On the other side you might say 'let's invest in healthcare companies because they're top-down defensive and they have non-discretionary sources of income.'" 

"But if you had invested in Australian Clinical Labs (ASX: ACL), Integral Diagnostics (ASX: IDXor Healius (ASX: HLSthe performance... is opposite what you were hoping to achieve."

Source: Bloomberg Consensus EPS estimates: Jun 2022 to Feb 2023

Then there's financials, arguably the most market leveraged sector out there. 

Source: Bloomberg Consensus EPS estimates: Jun 2022 to Feb 2023

Finally, consumer staples. "The safe part of the market." The same story plays out, as you can see below. 

Source: Bloomberg Consensus EPS estimates: Jun 2022 to Feb 2023

"That's why we're focused on the companies and not the macro."

Never miss an insight

Enjoy this wire? Hit the ‘like’ button to let us know. Stay up to date with content like this by hitting the ‘follow’ button below and you’ll be notified every time we post a wire.

Not already a Livewire member? Sign up today to get free access to investment ideas and strategies from Australia’s leading investors.

Livewire gives readers access to information and educational content provided by financial services professionals and companies ("Livewire Contributors"). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

1 contributor mentioned

David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.


Please sign in to comment on this wire.