Last month the Second Curve team had the opportunity to speak to a group of business students at Montclair State University. It was a great experience not only to engage with young minds, but to connect with Professor Bill Houlihan, the former CFO of Metris Companies and a longtime friend of the firm. The topic of the presentation “Macro and the Investment Process,” focused on several basic economic topics essential to investing.
While most professional stock pickers on Wall Street begin the investment process with a “bottom-up,” fundamental approach to company analysis, the financial crisis served as healthy reminder of the large, global macro trends that drive markets and will – at times – overwhelm company specifics. Let’s revisit three simple steps to keeping macro-awareness in your investment process!
1.) Start with the End Game
The ultimate goal for investors is to determine where we are in the economic cycle. As a brief refresher, a typical cycle begins with an acceleration in GDP growth which leads to wage and price inflation. Inflationary pressure triggers monetary and fiscal tightening meant to slow growth which often ends in recession. A recession puts downward pressure on pricing which leads to stimulus, and the cycle begins anew. Although it sounds fairly straightforward, the economy is constantly offering new – and sometimes conflicting – data points which can make future growth expectations difficult to predict.
2.) Avoid Paralysis by Analysis
The chart below highlights a list of thirty-three U.S. economic releases for the week beginning March 6, 2017. With over 160 reference points expected in the month of March, it is easy for investors to become inundated with data points. In order to separate market gyrations from economic fundamentals, investors must categorize data points.
3.) Follow the Leader
In the Cornerstone Macro chart below you will notice data points classified into four categories: Anticipatory, Leading, Coincident, and Lagging indicators, relative to whether they trough before, with, after, or well after the economic cycle. It is also important to notice that the stock market, itself, is a leading indicator of the business cycle. Obviously it is of little value for an investor to correctly predict a pending recession by pointing to a stock market in free fall! The investment community tends to focus on anticipatory trends because they lead leading indicators. Anticipatory trends are grounded in economic policy and inflation and measure the strength of future economic stimulus. Several examples include; changes in interest rates, money supply, access to credit, and inflation.
Where Are We Today?
While we enter the eighth year of the current recovery it is important to note that GDP growth has averaged a meager 2.1% per annum – roughly half the average of prior expansions. In fact this recovery marks the slowest of the 10 recovery cycles since WWII. Tepid growth is particularly surprising given extraordinarily monetary easing of the past eight years. This has created an environment where inflation expectations are beginning to rise (See: CPI expectations below) at the same time the Trump administration is preparing fiscal stimulus and the impact of monetary tightening should be minimal near-term with Fed Funds at just 66bps. The stage is set for the American economy to accelerate with rising inflation. Stay tuned!
What do you think? Let us know!