“Ignoring the Macro” Can Be Misleading
Value investors invest in businesses, not markets. Accordingly, many investors take pride in “ignoring the macro and focusing on the micro.”
In my opinion, investors shouldn’t take this adage too literally. I’ve seen too many financial market blowups to think that “ignoring the macro” is a good idea.
The term macro refers to macroeconomics, which is the study of the aggregate economy. Macroeconomics focuses on variables like unemployment, inflation, and total economic output. The term micro refers to microeconomics, or the study of an economy’s basic economic units (households and firms). Microeconomics focuses on prices, supply and demand dynamics, and consumer behavior. It makes sense, then, that value investors spend most of their time focusing on microeconomic considerations.
Awareness vs. Forecasting
There is a big difference between making economic forecasts and completely ignoring the macroeconomic environment. Warren Buffett has said many times that he ignores macro variables when making investment decisions. Buffett famously reads five newspapers a day. He has done so throughout his entire investment career. I just started talking about this on my podcast, Fundamentals Unfiltered, Episode 10. The truth is that serious investors pay attention to global events. They remain understandably skeptical of economic predictions.
Buffett spent most of his career investing through a publicly-traded holding company. He and his partner, Charlie Munger, built a fortress-like balance sheet and didn’t have to worry about investor redemption’s. They could weather shocks in ways that most professional money managers and individual investors cannot.
In other words, to be a long-term investor, you must first survive.
The Reality of Market Shocks
Credit markets collapsed twice in 12 years. Frankly, neither another financial market meltdown nor a global health scare is inconceivable to me.
I’ll share my experience navigating through those meltdowns another time. For now, I just want to make the point. Exogenous shocks can and will happen. They cannot always be predicted with accuracy.
Key Variables Worth Watching
Different investors will have different opinions on what variables to follow. Personally, I only focus on a handful of variables, which change from time to time. Now, I’m particularly focused on:
- The dollar index
- 10-year treasury yield
- Gold prices
- Credit-risk spreads
Rising Risks in the Global Economy
There are plenty of things to be nervous about. In a fiat money system, central bank credibility is key to anchoring inflation expectations. Politicalization of central banks is on the rise, especially in the U.S. So far, the guardrails have held, but this may not always be the case. If populist politics come to dominate central banks, we can expect inflation expectations to increase and interest rates to rise. Rising sovereign debt adds to the anxiety. Deglobalization complicates the situation further. Massive bets on AI contribute to the uncertainty. It is hard to imagine that investors are sleeping well these days.
More than anything, the private credit market makes me nervous. Estimated default rates vary, but every estimate that I’ve seen has default rates over 10%. Excluded in that figure is the rising amount of interest payments that are made “in kind.” In other words, more yield is being paid with additional debt. This happens instead of paying in cash. This practice could be viewed as a partial default. Private credit markets rose from near obscurity two decades ago to a nearly $2 trillion market. And private credit offerings will soon be available in retirement accounts. The influx of funds to private credit may lead to a lowering of credit standards in this space. The economic risks are uncertain, but they are real.
Sticking to Core Investing Principles
On a more positive note, my core investment philosophy hasn’t changed. I still look for companies with strong balance sheets, capable managers, and durable competitive advantages. I try to find companies that I think can weather a capital markets disruption.
And I only buy stock in these companies when the prices are below my conservative estimate of business value. In an uncertain world, the margin of safety is more important than ever. For more details on this approach, you can visit my post on 5 Timeless Lessons from Warren Buffett. In it, I break down the principles that continue to guide my investment decisions.
Summary
Ignoring macro trends entirely can leave investors blindsided by forces outside a company’s control. Long-term investing focuses on fundamentals. Understanding the broader environment helps protect portfolios from unexpected shocks. Interest rates, credit risk, inflation, and global politics play a crucial role. Successful investors balance micro-level analysis with macro-level awareness.
Key Takeaways
- Ignoring macro trends isn’t the same as avoiding economic forecasting.
- Awareness of global risks helps investors stay resilient through market cycles.
- Focus on key indicators like the dollar index, treasury yields, and credit spreads.
- Private credit growth and central bank politicization pose rising risks.
- A margin of safety remains the cornerstone of long-term investing.
