Congratulations to Egan Bernal, who overnight won the 2021 Giro d’Italia, one of the three cycling Grand Tours held each year. He completed the 3,479km over 21 gruelling stages in 86h17m to win by just 89 seconds! Having ridden many of the mountain climbs myself, I am simply in awe at the athleticism of the riders these days. Chapeau!
Today I’m going to write about “Macro vs Micro”; the impact both styles can have on markets, and how individual share prices can easily get distorted in the short term.
To start, going back to high school economics for a moment, I’m sure you all remember the difference between Macroeconomics (the big picture; inflation, unemployment, interest rates, fiscal and monetary policies, etc) and Microeconomics (the small picture; cost of goods sold vs revenue generated by an individual company, competitor product, etc).
Well, people who buy and sell shares, both retail and professional money managers alike, tend to look at investing from either a macro perspective or a micro one – some do both, but most start from the ‘top down’ (macro) or from the ‘bottom up’ (micro).
What I mean by ‘starting from the top’, is that you would study the overall economic environment first, forming a view on whether, say, inflation was likely to increase in the next few years – and what sort of businesses would do well in that scenario. You would then pick regions, sectors, and eventually stocks that you hope will do well in the environment you believe is coming.
Conversely, ‘starting from bottom up’, as you probably guessed by now, means finding individual companies that will be profitable because they can sell their product for more than they can produce it for, and have some sort of competitive advantage that will stop others from stomping on their turf, cutting their profit margins, and killing their businesses.
Both ways of finding stocks obviously have a lot of merit. Both are used on a retail level and by professional money managers around the world. There are sectors and stocks that will underperform as interest rates rise, and such stocks get excluded by top-down style stock pickers when trying to find the best stocks possible for their clients or themselves. If, and when, a macro style manager decides that interest rates are going up, they will generally sell those stocks they feel cannot outperform in a rising interest rate environment. And this is exactly what we have seen with technology stocks lately. Rising interest rates hurt theoretical valuations of growth stocks generally, and so many investors have been exiting such stocks, by selling anything even perceived to be considered ‘growthy’.
But will all tech/growth stocks struggle/underperform/fall IF interest rates do in fact go up?
I don’t think so!
Bottom up/micro managers, as I said above, focus instead on individual company fundamentals when picking their stocks. Profit = Revenue less Costs. What will help or hinder the revenue and costs of a company are front and centre of their thinking. Competitor products, supply of labour (like the apple farm in Bilpin I mentioned last week), and yes, factors such as inflation are also considered. The difference as I see it, is that a micro manager incorporates the effect of possible inflation (higher costs) into their valuation model, and if the projected revenue growth/profit margins are still high enough to warrant inclusion into a portfolio, the individual stock is not excluded from the investment universe, as it may be by the top-down style manager.
Business headlines are dominated these days by the heady growth of technology stocks, whether it is sustainable or not, especially if inflation returns with the government and central banks focus on generating more economic growth. Macro style investors who think the bell has rung on the tech sector in particular, have been extremely active in their portfolio management in 2021, exiting or lowering their exposure to the sector. In some cases, they may well have ‘thrown the baby out with the bathwater’, by a) selling stocks that will actually (out)perform in an inflationary environment, or b) the predicted inflation may not eventuate (as innovation has historically caused deflation).
Time will tell, I guess.
High conviction investing is probably closer to micro than macro in my opinion. The hidden gems that appear in high conviction portfolios are often unearthed by managers who dig down at the company or sector level and find stocks that will generate returns in any economic environment. We hold only the highest conviction ideas from our select group of managers, and they all believe the stocks we hold can and will deliver excess returns over the medium term. In the short term, we always expect volatility, as (the type of) market participants who dominate daily/monthly market turnover will forever be rotating, causing share price fluctuations that present opportunities to savvy managers.
Next month I’ll start going through the conference stocks again, reminding you what we hold, what the basic thesis is, and of course how they’ve performed. The HM1 May Monthly Investment report will be released sometime next week, but until then….
Chief Investment Officer
Hearts and Minds Investments Limited
Reminder: these are simply my general views and should not be taken as investment advice
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DISCLAIMER: This communication has been prepared by Hearts and Minds Investments Limited (ABN 61 628 753 220). In preparing this document the investment objectives, financial situation or particular needs of an individual have not been considered. You should not rely on the opinions, advice, recommendations and other information contained in this publication alone. This publication has been prepared to provide you with general information only. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Past performance is not a reliable indicator of future performance. This document may not be reproduced or copies circulated without prior authority from Hearts and Minds Investments Limited.