InvestmentsMar 29 2012

Balance of macro and micro inputs

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ByGareth Howlett

There are some generalisations about investment which are highly influential, intuitively convincing and largely wrong.

As a result most of us waste a lot of time speculating about things which do not really matter, and do not spend enough time analysing things that do. The most obvious example of this collective error, which is also a waste of billions of pounds of clients’ money, is the obsession with macro-economic forecasting, an activity whose real usefulness in helping us to make better investment decisions is, as far as the evidence goes, somewhere between astrology and feng shui.

But surely, you protest, there must be some sort of link between the overall health of an economy and its rate of growth, and the fortunes of the businesses based in it? After all, there is a huge overlap between what companies do (hire staff, make capital investments, buy supplies, sell their goods and services, and pay dividends) and the aggregate measures of national income which GDP statistics record. And if this is true, should it not also be true that the faster a national economy grows, the faster company profits and dividends will grow, and the higher the local stock exchange will rise?

This simple mantra, especially when combined with another widely held belief that the only decision that really matters is asset allocation, has encouraged investors to overweight regions (such as the emerging markets) where the expected long-term rate of growth is high, and to underweight regions (such as Japan and Europe) where growth is expected to be more modest. And below this strategic long-term level, there is a tactical obsession with short-term fluctuations in various sub-indicators. We sit and watch the numbers flashing across our screens and try to work out what they mean: German exports, Chinese inflation, US employment - on and on they come like an ever-rolling stream.

On the basis of the facts, the value of this work is a lot less than its cost. The most comprehensive survey of long-term equity market returns was published 10 years ago by Dimson, Marsh and Staunton. Their work, Triumph of the Optimists: 101 Years of Global Investment Returns, came out with pretty convincing evidence that over the whole of the 20th century there was actually a slight negative correlation between real GDP growth and stock market returns. This startling and counter-intuitive conclusion generated a flurry of interest within the academic community but seems to have been largely ignored by investors.

This lack of interest is surprising and depressing, because the reasons which explain why the negative correlation hypothesis might be true should be of interest to all investors who are genuinely inquisitive about the world they work in.