Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
When Macro Overwhelms the Micro
Published Date : April 29, 2024
When allocating to investments, understanding the dynamic relationship between macroeconomic and microeconomic factors is crucial. While microeconomic investing focuses on exposure to individual companies, macroeconomics examines broad economic trends, indicators and events that influence entire markets. Understanding the different elements can be helpful for investors especially when portions of the public markets, including individual stocks, move lower on good fundamental news related to earnings or other positive announcements. As experienced recently, there are times when the “winds of change” cause the macro backdrop to take precedence over micro factors which can impact the stock market.
Macroeconomic significance tends to rise during periods of economic uncertainty or significant policy shifts which is often why markets tend to have more directional volatility during interest rate cycles. Whereas past Federal Reserve Board members were more discreet in the free flow of opinions, the Fed in this period have been more transparent in their messaging. This transparency should be a positive, but economic conditions can change quickly causing investors to second guess the Fed’s next move in interest rates, a key underlying factor driving the money flow in and out of the publicly traded markets.
As macroeconomic uncertainties loom large, market volatility often spikes as investors grapple with the implications for their portfolios. Economic indicators such as GDP growth, inflation rates, unemployment figures and geopolitical events become critical drivers of market sentiment. Adverse developments in these macro areas can create headwinds for stocks, causing sell-offs due to increased risk aversion. Case in point, the highly followed Chicago Board Options Exchange Volatility Index (VIX), an up-to-the-minute market estimate of the expected volatility of the S&P 500 Index over the next 30 days, recently made a 45% upward move from the 13% level to 19%. The rise in this sentiment indicator reflected the expectation that price swings in U.S. large-cap stocks would become more dramatic. The good news is, whereas the 13% level was low versus history, the 19% level is near the long-term average.1 In our view, this movement partly correlated with a realization by investors that the Fed is indeed less interested in lowering the Federal Funds interest rate now than communicated during late 2023.
In contrast to the macroeconomic headwinds, certain aspects of microeconomics, specifically earnings results from public companies, can function as a ballast. While companies can’t control the macro, they are driven by incentives which affect the distribution and utilization of company resources designed to drive positive earnings outcomes. The strongest companies are often able to maneuver through the macro environment to deliver impressive earnings results over an elongated period. In the recent period since Q3 2023, we have seen a resumption of earnings growth in the S&P 500.2
Although investors often ignore macroeconomics when choosing investments, we find it important to track both macro as well as the micro. Keeping an eye on key economic indicators and central bank policies can provide valuable insight into the market, helping us judge when sentiment has swung too far in either direction. To further mitigate the effect of rising volatility, we are also strong believers in diversifying across asset classes and sectors which can help provide portfolio stability.
Without a crystal ball, it is impossible to say if the macro conditions will calm down or heat up, but we will continue to seek investments in companies which have shown the ability to make good business decisions over time. Should sentiment swing too far south, we might get the opportunity to take advantage by adding exposure in best-in-class companies at attractive entry points.
1-www.investopedia.com/terms/v/vix.asp
2-https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_041224.pdf
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