Lately, stock market commentary has been all about macro-economic and geopolitical events. Tune in to any business channel or pick up any brokerage report, and you get erudite debates about the US Fed’s dot-plot, RBI’s trilemma, the British pound’s woes, Italy’s far-right pivot and China’s zero-Covid policy, with closing remarks on what this cocktail of variables could mean for Indian markets.
If you’re a layman (or woman) trying to build a long-term stock portfolio, this is daunting. Should you be looking to buy a dip in Indian stocks when the global economy is staring at a recession? Shouldn’t you wait for RBI to reveal its entire game-plan on rates before buying the stocks you like? Should you sell everything you own before the US Fed unwinds its $8.8-trillion balance sheet, causing global mayhem?
Should you be in the markets at all when you don’t know the first thing about macros or geopolitics? The brief answer is that you should.
Why macros confuse
There are three good reasons why all successful global stock-pickers from Peter Lynch to Warren Buffett to Howard Marks have expressed a strong distaste for getting bogged down by macros, when betting on stocks.
One, for macro analysis to be of some use in your stock selection, you need to get macro events and their impact on the markets right. But the truth is that the global economic and geopolitical forecasts often get blind-sided by Black Swan events that no one saw coming. If you were to list out some of the most destabilising macro events of the past two decades, it would include events such as the 9/11 World Trade Centre attacks, the Lehman collapse, demonetisation in India, Covid-19 and the Russia-Ukraine war. Hardly any macro forecaster, unless clairvoyant, would have seen these coming.
Even when one is in the midst of such disruptive events, gauging their impact on the economy and other macro variables is a thankless task. When Covid began in early 2020, very few experts could have predicted that it would last for two years, lock down global borders and yield surprising dividends for FAANG stocks in the form of global digital adoption. When the Russia-Ukraine conflict broke out in early 2022, hardly any geopolitical experts expected it to last for this long or predicted that it would cause runaway inflation or prompt central banks to dial back on their QE.
But even without such Black Swans flying into the picture, macro forecasts are often wrong. In a June2021 memo, contrarian investor Howard Marks made a strikingly logical point on why he disregards macros while investing. He argued that macro forecasts, when they are right, are often consensus expectations which are already factored into asset prices. Non-consensus macro forecasts (which aren’t in the price) are often wrong.
Two, trying to get on top of macro events is of little practical use because stock prices seldom reflect what’s happening to the economy, either during or after the fact. One would think that periods of high GDP growth, benign inflation and low rates would be great for stock markets and vice versa, but history tells us otherwise.
Between 2003 and 2010, the Indian stock market enjoyed one of its biggest bull runs ever amid high inflation and rising interest rates. Between March 2020 and 2022, Covid-19 inflicted an enormous toll on human health and economic activity. But this was a period when global stock markets took off in a massive rally that created enormous wealth for those lucky enough to stay invested.
Multiple empirical studies have proved with data that the long-term correlation between GDP growth and stock market returns, in most economies, is negligible. BNY Mellon, after studying trends in quarterly GDP growth and movements in the S&P 500 between 1970 and 2012, concluded that the correlation between the two variables in the US market was virtually zero, with the study yielding similar results for Eurozone and German stocks.
The weak correlation between the economy and stock market moves holds true for India as well, because here, listed companies make up a relatively small sliver of economic activity. Agriculture and services, which account for 80 per cent of India’s GDP, are under-represented in the listed universe and the unorganised sector dominates the economy and employment. Experience suggests that stock prices often discount macro variables before they materialise. Therefore, trying to read the tea leaves on where GDP, rates or inflation are headed and trying to make your stock moves based on this, can make you miss the bus by a mile.
A third reason why a stock investor may be better off ignoring macro and geopolitical events is the sheer frequency of them, which can lead to ‘analysis paralysis’. If you were to wait for a blue-sky scenario where no country in the world is being threatened by macro or geopolitical risks before taking the plunge into equities, you may very well end up waiting till your hair greys. Trying to track and decipher the impact of every global event on your portfolio can be a drain on your time that would be far better spent understanding what makes a business or a company tick.
How to use macros
Having argued that macros are of limited use in helping you make the right stock choices or timing your investments, how can you use them?
· Because macro-economic or geo-political events have little impact on long-term stock returns, you can look on them as opportunities to buy or sell stocks at valuations you like. In hindsight, some of the best periods for investors to buy equities in recent history came just after the US housing collapse in October 2008-March 2009, the 9/11 attacks in September 2009 and after Covid was identified as a global pandemic in March 2020. So, if macro or geopolitical events cause stock market mayhem, that is usually a good time to bottom-fish stocks or the indices. Use valuations as your guide to gauge if it is time to bargain hunt.
· Remember that stock prices are slaves to corporate earnings, and not to GDP or other macro variables. If you’re keen to act on a macro event, do so only if you can drill down the impact of that event on the earnings of the company you’re looking to buy or sell. For instance, rising inflation may call for focussing on companies in oligopolistic sectors or those with high pricing power. Rising commodity inflation may be the cue to relook at companies in IT or BFSI without raw material risks.
· The relative equation between equity valuations, interest rates and inflation can help you decide on your asset allocation. A high yield, slowing GDP scenario for instance favours a higher allocation to bonds versus stocks. But to make such allocation decisions, your forecasts of rate/GDP direction need to be right, which is a tall ask. Therefore, don’t make wholesale shifts between assets based on any one forecast or forecaster. Go by probabilities. Use the current valuation of any asset relative to its alternatives and own history, before making allocation calls.