My Macro Framework

I just wanted to consolidate what I understand about macro by writing down my framework, so please pick apart my ideas piece by piece (Sorry if some of the stuff I write sounds incoherent). Of course I’m still an inexperienced student in university, so my framework might be underdeveloped. Still, there is so much to learn when it comes to macro and right now I am just writing down the main aspects of macro investing that I believe to be essential.

When it comes to understanding macro, there is a short run analysis and a long run analysis. Long run analysis is essentially analyzing the decade long growth trend of an economy while short run analysis is analyzing the short term (ie business cycle) of an economy.

While its good to learn about the long run, it’s not exactly applicable to investing, other than the solow model in relation to Emerging Markets. The main idea of long run analysis is that all economies grow in the long run. Some grow faster than others due to where they are positioned relative to their steady states. Therefore, given enough time, your money invested into an S&P etf will compound to a decently sized gain (you just have to be patient about it). As Warren buffet says, index investing are one of the few free lunches one can get.

However, the main problem in regards to long run buy and hold for retail investors is timing and liquidity. If you invested into the S&P 500 at the peak of 2008, it would have taken you a massive amount of time commitment (ie opportunity cost) just to regain back the principle amount. Not to mention, with limited savings, many would be forced to liquidate their portfolio in order to make ends meet. Therefore, while holding onto an S&P etf seems like a fair strategy to grow one’s wealth, there are major flaws that come with it.

So what is the next best thing? Having a tactical allocation based on a top down macro perspective. When it comes to short run analysis, economic growth fluctuates around its long term trend growth. These deviations from the trend create what we know as economic or business cycles. The point of tactical portfolio allocation is to position one’s portfolio to be optimized across these cycles.

For instance, you see recessionary headwinds so you position your portfolio to more defensive sectors/asset classes, maybe liquidate the majority of your portfolio in cash or treasuries to build up dry powder for potential buying opportunities. When you see a potential recovery in the economy, you can start allocating to more growth oriented sectors and be more aggressive with your risk taking. The main idea around tactical allocation is to ideally minimize portfolio drawdowns and let the compounding do the work. In reality, implementing a good tactical allocation is really hard as one would need to consistently make the right directional calls over the span of a decade.

However, investing isn’t just coming up with the right thesis, but also includes identifying market dislocations/inefficiencies as well as structuring your trades in a way that would be asymmetric in terms of risk to reward. There are several other ways to make up for your returns despite having the wrong macro thesis and vice versa.

When understanding macro, you also have to understand that everything is connected to each other in one way or another. These markets are all driven by three main forces: GDP growth, inflation, and interest rates. Having a better than market forecast of these three forces is where majority of a macro investor’s alpha comes into play. There are a million ways to approach this (ranging from monetary policy to currency flows, geopolitics, fiscal policy, debt etc).

Also, never underestimate the efficiency of markets in pricing in the macro. For instance, in recent times, despite US economic data showing an economic slowdown and easing inflation (which implies a potential long term fed pivot), tech as well as other growth sectors rallied. The reason why? Markets overreacted and significantly discounted tech in preparation for a recession. The tech rally was just a correction to this overreaction. Therefore, if one were to remain defensive throughout that period and under allocated to tech, the fund would be significantly underperforming despite the macro thesis being right.

Let me know what you think about this framework.