August 06, 2022

Macroeconomics is a top-down process that looks at the big-picture performance and overall state of the economy. Macroeconomics attempts not only to measure how well an economy is performing, but also to understand what forces drive it and how government policies can help achieve the desired objectives. To the extent that it provides a more thorough understanding of the effects of broad economic trends and policies , the information generated by the economic analysis may help investors make better decisions. The underlying economic principles upon which designs its policies says much about how that government will approach taxation, regulation, government spending, and similar policies. By better understanding the economic orientation of the administration , investors can get at least a glimpse of how this administration will react to different disturbances and determine the government’s probable future and act accordingly. This analysis is the foundation of a top-down portfolio strategy. It can be invaluable to understand which theories are in favor and influencing a particular government administration. The first step in the development of a macro driven portfolio strategy , which we outlined in our previous publication, was to develop a simple framework that allowed us to generate forecasts of the economy’s market clearing prices and quantities. The focus of macroeconomists and investors is quite different. Macroeconomists are mostly concerned with developing policies that achieve desired policy objectives while investors and portfolio managers focus on achieving the highest possible returns for their clients. For both groups it is important and worthwhile to keep track and forecast the major macroeconomic indicators like GDP, inflation, and unemployment. The macroeconomic statistics can help an investor make better decisions and spot turning points. The performance of companies, and by extension their stocks, is significantly influenced by the economic conditions in which the companies operate. The second step , which we discuss today , details how changes in key economic indicators impact the valuation of different assets, i.e., short, and long bonds, large and small caps, value, and growth stocks, as well as domestic versus international stocks, among others. The impact of the changes in these indicators on the valuation models allows us to assess the changes in absolute and relative rates of return of the different assets. In our third step , we use this information and combine it with the capital asset pricing model CAPM allows us to outline a macroeconomics modified CAPM portfolio strategy.

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