Sometimes investors hear analysts and fund managers refer to “macroeconomics” in their explanations of investment decisions. So what is macroeconomics?
Put simply, it’s a way to break down the broader idea of economics — the interplay of labor, intellect and capital — into two major subgroups: macro and micro.
Microeconomics is what you paid for a banana today at the grocery store. Macroeconomics is the changing price of fruits and vegetables across the country over the last 12 months.
Macroeconomics covers topics as varied as inflation, economic growth (measured as gross domestic product, or GDP), the job market and industrial and farm output. The goal is to accurately measure how much these indicators change over time in a bid to understand why.
For instance, if inflation is higher than expected, is it because the interest rate is too low? Is money too cheap and thus fueling grow faster than we might like?
If unemployment spikes in one month or over three months, what’s going on? Are workers being laid off because of poor sales? Or are companies demanding skills that few workers can provide?
Investment managers pay attention to macroeconomic ideas because certain companies in which they are invested already or might choose to invest could benefit if growth is stronger than expected.
For instance, if you knew that housing prices were rising faster than normal you might ask why. You might learn that builders underestimated demand and that hiring was on the rise.
That might lead an investor to buy a real estate investment fund in order to capitalize on growing demand. Or, perhaps, to buy a home builder’s stock.
If the investor learned instead that housing was going up for no discernible market reason — which in retrospect was happening in 2007 — the investor might bet that banks were over-lending.
A prudent investment decision in that case would be to sell financial stocks or even short bank stocks in anticipation of a price correction.
As appealing as these strategies sound, there is no guarantee that any given macroeconomic analysis will turn out to be correct. Even if correct, the mass of investors could continue to invest contrary to the facts for a longer period than you might be able to stand.
As the late British economist John Maynard Keynes put it, “Market can stay irrational longer than you can stay solvent.”
Rather than attempt to forecast the future based on economic trends of the moment, it’s often better to focus on the level of risk that is appropriate to your goals.
Do you have decades to invest? If so, stocks have proven to be long-term winners if you purchase them in a diversified manner.
Only a year or two before you need your money? In that case, consider bonds to be a better choice or, perhaps, cash. You won’t make a killing, but it’s much more likely that you’ll still have money when you need it.
Most long-term investors decide on a balance of stocks and bonds in order to get a the best of both worlds. If properly spread among a large variety of investments, the specific events of a macroeconomic analysis won’t have much bearing, if any, on your investment choices or performance over time.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.