How Much Macro?

What follows is a discussion of one of the most important issues facing analysts, especially young analysts.

How much emphasis should you place on “macro factors” when picking stocks. I will define macro factors as both the expected return on the market going forward, and also a prediction on GDP trends/earnings trends and interest rate changes.

I think there is a continuum of approaches. You need to think carefully about which one you choose, and apply it consistently. You should also be aware that many investors claim they do not use macro factors, but then pick stocks almost exclusively based on macro factors.

Let’s review the different approaches:

0% Macro - Let’s pick stocks without any concern for macro factors. I used this approach from 1982 to 1999. I was aware of macro factors, but I never used them to pick a stock. I assumed stocks would go up about 10% a year, and economic growth would average 2% per year over the next 5 years. If I could find a stock that could return 20% over the next 5 years it was a buy. This was a simple way to live, and is probably the best place for a young analyst to start. Often this approach just means avoiding economically sensitive stocks, which can limit the number of ideas available. It is hard to recommend a steel producer without some view on the economy.

25% Macro - Let’s call this the reasonable approach. This is the approach I chose for the model portfolio. Some of the stocks chosen were for “macro” reasons, the gold stocks and the utility stocks. My concerns about economic growth limited my use industrial ideas. But I still picked Brunswick, Omnicom, Corning, Red Rock, Viad, and Ruth’s, which all have significant economic exposure.

50% Macro - Let’s call this the common approach. I think this is the choice of most professional investors. Maybe half the stocks they own can be traced to some economic rational. The other half are chosen for stock specific reasons. This is often the choice of those who claim to “not look a the macro”, yet their portfolio has clear macro tilts.

75% Macro - This is the second most common approach. If this manager is bullish you will find plenty of technology and industrial stocks, or if bearish he will own consumer staples and healthcare. They will still own a few ideas not based on macro factors.

100% Macro - This is a specialty approach used by only a few hedge funds.

Some depend more on market calls, while others try to pick specific industries based on their GDP/interest rate call. Many have specific predictions on energy stocks.

There is no right answer. Economic forecasting is very, very, very difficult. Trying to have a non-consensus opinion takes considerable experience and skill, but it can be done.

Taking a consistent approach is crucial. What you want to avoid is getting bullish on cyclicals too late in the cycle when their earnings are strong, and avoiding cyclicals when they are losing money.

We will attempt to address the macro issue with every industry we evaluate, and every stock we select.