September 04, 2022

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. The underlying economic principles upon which designs its policies say much about how that government will approach taxation, regulation, government spending, and similar policies. 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. 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 a previous publication, was to develop a simple framework that allowed us to generate forecasts of the economy’s market clearing prices and quantities. 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 discussed in an earlier report, detailed 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 allowed 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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