Getting macro right vs. individual stock selection

If you could choose between either getting the macroeconomic trends right or the individual stock selection right, which would you choose? It seems to me so much of earning "excess returns" in investing is derived from getting the macro picture right, and very little is derived from choosing Coke over Pepsi, or Nordstrom over Saks.

I've just recently finished recruiting for buyside equity research roles (MBA level), and the biggest take-away is that the vast majority of the large funds are strong bottom-up shops. They are excellent at identifying sustainable competitive advantages, favorable marketing practices, or strong management teams. Yet most of these funds seem to detest doing any sort of macro analysis, and developing a thesis based on where the global economies are likely heading. This seems backwards to me - it seems like the way to outperform is to get the macro right first, and then worry about the competitive dynamics. Obviously forecasting macro trends isn't easy - most economists fail miserably at it. But isn't there some value to be gained in at least trying?

Obviously there are some great top down shops out there (i.e. PIMCO), but why is so much of the institutional emphasis on bottom-up? Thoughts?

Comments (12)

Dec 5, 2011 - 6:28pm
JeffSkilling, what's your opinion? Comment below:

This is a really good question as it is highly relevant to the world we live in. In the current context of the world, understanding the Macro environment >>>>>>>> understanding stocks. This why CNBC is such bullshit, all they talk about is whether Kinect is going to be the hit Christmas season console and how it could finally lift the stock. Give me a fucking break. This is not just some cyclical downturn that we are suddenly going to start booming out of, this is secular. When the debt overhang becomes so incredibly large, a nation cannot grow without the presence of private credit demand.

We are doing the exact same thing Japan did (Propping up Zombie banks and embracing Keynesian policies). Who in their right mind cares about stocks right now? Kyle Bass put it best, in the next few years "I'm more concerned about return of capital than return on capital".

Dec 5, 2011 - 6:13pm
dazedmonk, what's your opinion? Comment below:

"Institutional" son.

L/S equity is the oldest game in the book. Anyone can understand it. The vast majority of successful managers have focused on equities (including equities derivatives), with at least some fundamental basis. People like old, traditional, and methodical. Makes your pension fund investors sleep much better at night.

  • 1
Dec 5, 2011 - 6:32pm
SlyGuy, what's your opinion? Comment below:

Institutional road the coattails of the "Great Moderation" of macro conditions in developing countries that almost every leading monetary/financial economist now acknowledges was, literally, too good to be true. Now that we are off the Kool-Aid, macro is in. And I think it is here to stay. The institutional L/S guys made money consistently in spite of their lack of attention to macro conditions to the historic anomaly of the Great Moderation. So, in conclusion: macro. That said, I think macro is harder on a conceptual/intellectual level to get right.

Dec 5, 2011 - 8:36pm
za3212, what's your opinion? Comment below:

^^ what everyone else said

also, getting a macro trend right is potentially more profitable - there are almost infinite ways to capitalize on a macro trend

Dec 5, 2011 - 9:01pm
syntheticshit, what's your opinion? Comment below:

this is something i struggle with, because i work in a multistrategy setting that tries to juggle both (preserve bottoms-up alpha while implementing large top-down calls)--

in the end, what really constitutes "bottom-up" stock picking versus more "macro" trends is really not quite as distinct as it is posited on paper. As a bottoms-up equity picker, Fama-French-Carhart factors (value, size, growth, momentum) account for a staggering amount of your "alpha"; it is very hard to claim that your stock selection abilities are separated from an interplay of those 4 basic factors. value as a general rule is negatively correlated with momentum (a very intuitive idea), but is understanding the interplay of these factors really macro or fundamental?

it's easier to think about the world if we separate stuff into risk premia we understand relatively well (size premia, equity value premia) versus stuff that is more exotic (volatility insurance premium, forward rate bias, commodity momentum, merger arbitrage, etc.). if you're good, you can get away with charging 2 and 20 for delivering illiquid exposure to more exotic bets and pass it off as "alpha", which is just a fancy way of saying a manager's alpha is just exotic beta waiting to be discovered if you can deliver it in a systematic fashion.

"macro trends" is really lazy shorthand for a combination of broader trends that are more invisible at first glance, including geographic factors/interest rate risk/whatever, with more flexible instruments to allow more nuance for a view (currency, inflation swaps, e.g.). the attractiveness of being able to call "macro" right is, as some of the above have said, the ability to size more wildly because of your broader universe. but back to the original point: is saying U.S. distressed debt will offer better risk-adjusted returns than U.S. large-cap equity a macro call, or is it a cross-asset relative value call, or it just a generalization of an inherent capital structure idea (which is very very very fundamental bottoms-up)?

nailing the broader trends is incredibly important because it will contribute the most to your performance. why most people advertise themselves as great "bottoms-up" pickers is because they are either macro-agnostic or do not want to advertise themselves as being experts at something they don't study. it also is incredibly difficult, because what ultimately drives a lot of these "macro" calls is more human, and direct causality is even more difficult to prove.

Best Response
Dec 5, 2011 - 10:07pm
jankynoname, what's your opinion? Comment below:

Some really interesting comments - thanks guys. It seems like the consensus is that macro will be pretty essential going forward. A lot of you seem to be at HFs where you have a lot more tools in your arsenal than a person at a long-only shop (i.e. me). Yet I still think it's going to be important for the long-only folks to understand the sea changes. Let's face it, if Portugal falls, Spain probably falls. If Spain falls, most of the EU collapses, and then we're either into some severe inflation (debt monetization), or major austerity which will likely tank most economies in the world.

I think if this happens the fact that Bank of America trades at a discount is going to be irrelevant (the bank stocks probably go to zero). And so then it becomes a question of what sectors are insulated from a Japan-like lost decade, and which will be hit the hardest? I just hate thinking that at many of these funds you're spending all of your time comparing the Titanic to the Hindenburg. Gotta see the forest sometimes too.

BTW, @syntheticsht - the fact that a lot of alpha can be explained by Fama-French doesn't bother me. In the end, active managers are still making a call on where they expect those risk premia to be, and therefore what the returns are likely to be. It's not as simple as just saying "let's overweight small cap/value". I think active managers are paid to make sector and capitalization allocations. Academia wants to benchmark these guys against the exact style that they have, but ex ante it's not obvious that they should have those styles, so I think that's unfair. Active managers should be rewarded for picking the styles that outperform (in the broadest "entire market" sense).

Dec 5, 2011 - 11:04pm
GekkotheGreat, what's your opinion? Comment below:

Depends... Different times, different approach.

Right now, it's all about getting the macro right. When there is no major risk factor and the economy is stable, then it's about picking the winner.

Dec 6, 2011 - 12:11am
rothyman, what's your opinion? Comment below:

It all depends on your trading personality. Market Wizards interviews traders who believe in bottom-up and top-down analysis. I think both can be successful depending on your personality.

I myself like to use top down analysis, because I feel as if I won't get hit with any 'unexpected' macro events if I do my research. Then again, even if you do all your research you still can't be sure. It seems as if one individual changes their mind on any given day, the macro picture can be thrown into a tailspin immediately.

Dec 6, 2011 - 6:29pm
Ovechkin08, what's your opinion? Comment below:

Ships will sail around the world but the Flat Earth Society will flourish. (Ben Graham) There will continue to be a wide discrepancy between price and value in the market place, and those who read their Graham & Dodd will continue to prosper.

Regardless of the macro viewpoint people will continue to drink Coke, eat at McDonalds, wear Nike shoes, chew Wrigley's gum, check out WalMart for the latest deals and buy car insurance from GEICO . Leave the macro forecasting to the soothsayers who charge 2 and 20 and deliver little in return.

Just my 2 pence.

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Dec 6, 2011 - 8:35pm
thunderfan118, what's your opinion? Comment below:

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