Sunday, April 1, 2012

Macro vs. Micro

The talking heads on financial television networks and writers in general circulation news media spend most of their time on minute changes in what they perceive to be the principal macro trends affecting today’s markets, with the underlying presumption that what influences today will affect long-term future investment results. Relatively little attention is paid to the stories behind individual company press releases. This focus is understandable, but not particularly useful to investors. Less dramatic changes in work procedures, the make-up of sales, supply-chain evolutions, shifts of key personnel below the board level, etc., are somewhat difficult to ferret out and appear to be dull to journalists.

I like listening to smart investors and that is why I try to attend a monthly meeting of an investment group where the participants have at least 40 years of investment experience. While one of the purposes of the group is to develop actionable ideas, most of the time is spent on top-down or macro thoughts. That way almost all feel that they have something to contribute. When the discussion finally turns to individual securities, the number of speakers drops considerably. As many of the members of this group are no longer working or managing money intensely, they are not doing detailed fundamental research on individual securities/commodities. An expressed view is that good security selection will come out from the correct macro decisions.

I disagree with both the pundits/media and some of the members of the investment group who share this view. Many of the members of various investment committees that I serve on want to discuss the macro trends. Most of the time I believe that it is very difficult to spot a changing macro trend in advance. However, there is one way that I have found useful in the past. When I have talked with various companies’ CEOs, heads of product research, heads of marketing research, and heads of sales among others, I can occasionally find out what is keeping them awake at night. Often I can determine how far out the time horizon that they are thinking about is, and how this has changed. Thus from the bottom up, I can sense changes before they are full grown macro trends. There are times when several well-managed companies foresee changes that can be an important macro change. I wonder whether they still say about tournament golf, that you drive for show, but putt for dough. Which suggests it is the smallest detail, getting the ball in the hole with the fewest number of strokes which wins.

Top-Down Macro Thoughts

In this blog I am going to constrain myself to top-down thoughts due to space considerations and to provide the widest utility to this community. In future blogs I will outline some micro analysis I use in selecting funds, fund managers, and individual financial services securities.

The following is a list of items that could lead to serious macro trends:

  1. In December, US money supply measured by M2 grew by 10% year over year (somewhat less currently), while the US economy grew, depending what source one reads, at 2.8-3.0%. Historically if these trends continue, the fear of rising inflation can drive markets. (We have recently increased commitments in TIPS.)

  2. Because a limited number of corporate defined benefit plans have gone broke, a couple of state legislators are proposing that the states manage money for the private sector. While I doubt, for good reasons, that this will happen, the desire on some parts to have government take more responsibility for the private sector is raising a flag of concern as to the long-term financial health of those states and perhaps the society in general. A trend to be watched.

  3. Courtesy of Protégé Partners and Welling@Weeden, I have seen some evidence of behavioral concerns facing the ability to retire. (I don’t intend to retire, as I hope to go out as they say, with my [combat] boots on.) Considering that many people voluntarily or involuntarily retire at age sixty, the number of younger people in the society to some degree assures the retirement funding in various government plans. In the US, this so-called dependency ratio has gone from 17.2 % in 2007 to an expected rate of 25.4% in 2040, or about two less people to support us. The US is in relatively good shape, for at the same time the dependency ratio in Japan is estimated to be 43.3%, Canada 31.5% and China 27.9%. (These statistics suggest to me that most of the global world must shift more of its resources into some form of savings, which will drive the investment markets higher. This, in turn, will reduce the amount that has to be shifted. But whatever is shifted will come out of consumption, which means that market valuations will rise even at the same time secular growth slows.) While the various austerity measures being introduced will also reduce consumption, they eventually will lead to lower personal debt, in part because of the write-offs of bad debt. After the calamity of the 1930s, personal debt in the US had returned to its lowest level since the Civil War; while in the 8 years from 1933 to 1941 the US economy doubled in real terms. So austerity measures can work in the long run if the political conditions are reasonably stable.

  4. Globalization may help the world manage risks better as well as transmit them faster. The stock exchanges in the BRIC countries (Brazil, Russia, India and China) are cross listing the other countries’ derivatives. In a “risk off” world there will be fewer places to hide. One of my concerns in our changing market structure is speeding up the transmission belt of global problems. In February the number of ETFs (Exchange Traded Funds) was relatively stable with the January roster with the exception Global/International Equity ETFs, which gained 22 new funds in the month for a total of 439. Many of these funds are getting narrower and narrower based, e.g., the new Markets Vectors Indonesia Small Cap ETF. Open End Mutual Funds are also responding with the newest post card I received announcing the Wasatch Frontier Emerging Small Countries Fund. (As many of the readers of my blog know, I have been an advocate of investing in Asia both in large and smaller countries. At this point, except for truly long-term oriented clients, I will not add to these positions. I get nervous in crowded market places.)

  5. Commodities and commodity producing/transporting stocks play an increasing role in many sophisticated portfolios. Commodities, a lot like bonds, move to a different drummer than equities. Often they are more sensitive to changes than equities. There is at least one manager who believes that commodities are over-priced based on historical standards. (Currently, there may be too much weight being placed on China and its thus-far managed slowdown.) Higher commodity prices bring on to the market new production which we have seen in metals and grains. For example, US farmers are planting the most corn in 75 years. Only time will tell whether this is an example of speculative excess.

  6. In Saturday’s Wall Street Journal, the very perceptive Jason Zweig devoted his column to a recent study of how well Lord John Maynard Keynes managed a portfolio for Cambridge University. The article and a subsequent exchange of emails is an appropriate summation of the skills of what started out to be a macro-driven fund and became a micro selection device. After Lord Keynes with his insight as an adviser to the Bank of England missed getting out of the 1929 decline, he shifted from a macro focus to using alternately cash, selected commodities and small/mid cap stocks. In effect he went very wide of the benchmark index that other fiduciaries used. By doing so he was able to add 8% per year in excess return. What we do not know is how well each component of his portfolio fared against a relevant index. While that would matter to me as an analyst/portfolio manager, I am sure it did not matter the Cambridge dons (professors).

Tentative Investment Conclusion

One needs to be alert to the macro concerns now more than in the wonderful first quarter.

What do you think?

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