why so little macro on the due diligence for equity research?

Goodwill11's picture
Rank: Monkey | banana points 50

the title is pretty straightforward. I am wondering why such little attention is devoted to the classic "bigger picture", aka macroeconomics on a regional / zone / global scale as opposed to the in depth diligence on all the things relating to the industry (sector demand/supply, competitive dynamics, players, business model, etc). please note that:

  • I by no means think that the latter is less important, it's a vital component to a make-it-or-break it approach to stock picking
  • I by no means think that macro is easy (in a 3 months + optics) to understand, predict, gauge in a rsk management perspective
  • I by no means think that weighing the chances of the stuff that has to happen at micro and macro level is nothing less than very tough

but, looking at the markets, at how stocks behaved, at how they reacted when stuff happened, I couldn't help but notice that a great variety of great fundamental thesis (not mine, but I was sold on the idea) backed up by very smart, extensive and diligently done due diligence proved to be total disasters even in a year horizon (taking into account longer time horizons for value plays to play out) all due because the macro picture materially changed (or it revelead itself for what it was).

in essence, why, most of the time, macro is overlooked (or at least it's what looks like to inexperienced readers like the undersigned here) or implicit hypothesis are not included in the modeling / reasoning ?

after all, even in dispersed sectors where competitive positioning excercises a much greater influence in dividing winners and losers (unless it's stretching an underlying macro thing to the limit, so there's compression on the way down) , a very significant part of the value drivers is strongly correlated with macro variables...

can somebody shed some light on the matter to this very much in the dark 'monkey'?

Comments (10)

Feb 9, 2016
Feb 9, 2016

because the micro research is easier to manipulate into what your clients want to hear

Feb 9, 2016
PassionBucket:

because the micro research is easier to manipulate into what your clients want to hear

LoL. the funny (not so much in reality!) thing is I do not know whether you are serious or not!

Feb 9, 2016

great question, one of the better ones I've heard here. here's the thing, at BB shops where you have both coverage teams for individual names and economists/strategists, you will see some overlap. meaning, if I'm covering XOM, I can't help but talk about the oil price, or if I'm covering PG which has over half of its earnings abroad, I can't help but talk about currency or global demand.

the thing is, it's pointless to spend much time on those things because the companies don't have a choice on the environments they operate in, they have to play the hand that's dealt. and sure, they will adjust some things depending on the macro backdrop, but it's out of their control. ER analysts are charged with reporting news on the company as it relates to their investment thesis and forecasting what should happen given a normal market environment. I've never seen a report that bakes in a recession into their base case or assumes a 50% drop in the S&P. #1, it's impossible to forecast, and most importantly #2, it's bad for business. being bullish pays, BBs get paid on volume of trades, not soundness of advice, so you can see the disconnect.

also, it's not all that useful in my opinion. what would your report say? well Visa should continue to execute on its core strategies, but we're forecasting a 30% drop in equity prices and a global slowdown so you shouldn't invest here. that would never happen. what you will see is the strategists putting out pieces on what they think about the markets, but again, their job is to be bullish, I've never seen a strategist (not one who's currently employed) be outright bearish.

here are some things you can look for:

  1. tone. strategists will never outright claim that a crash is coming (not sell side anyway), but they will change their tones when they are less optimistic, which is usually a sign that turbulence is coming.
  2. pay attention to earnings season. companies will give guidance and good ER analysts will comment on that guidance. while its true companies manage earnings so they can have positive surprises when their restricted stock vests, companies' tones will also change depending on their level of excitement/pessimism.
  3. valuation is everything. this is self explanatory.
  4. the best you can hope to do as a long investor in a bear market is lose less. you do this with a sound fundamental thesis, and if your names happen to get beaten down more than you think is justified, you buy more of them, so always have cash on hand.
Feb 9, 2016

Long story short:
Macro is fucking hard. Clients will trust their in-house research more or go to a specialized consultancy. The way nearly all bb analysts are trained also leads to tunnel-vision; they only focus on a basket of stocks and only occasionally study up on cross-industry dynamics.

Feb 10, 2016
giantdad:

Long story short:Macro is fucking hard. Clients will trust their in-house research more or go to a specialized consultancy. The way nearly all bb analysts are trained also leads to tunnel-vision; they only focus on a basket of stocks and only occasionally study up on cross-industry dynamics.

macro is hard: absolutely. but it's also vital to the poor analysts if they wish not getting burnt. also, if I may add, inefficiently: it's not like that buy side analysts won't invest a lot of time in researching other things which require extensive checks and "hard" data to back the thesis (at least the good ones do, and finding this stuff is tough) so it's not like you don't have to spend time on analyzing things. marginally in a bull market, it pays more but if you happen to be in a bear one, all the work you've put (and on which you'd have been right given another set of macro dynamics) is rendered useless. marginality = 0 (or even negative if your spot was on the verge of being fired).

thebrofessor:

the thing is, it's pointless to spend much time on those things because the companies don't have a choice on the environments they operate in, they have to play the hand that's dealt. and sure, they will adjust some things depending on the macro backdrop, but it's out of their control. ER analysts are charged with reporting news on the company as it relates to their investment thesis and forecasting what should happen given a normal market environment. I've never seen a report that bakes in a recession into their base case or assumes a 50% drop in the S&P. #1, it's impossible to forecast, and most importantly #2, it's bad for business. being bullish pays, BBs get paid on volume of trades, not soundness of advice, so you can see the disconnect.

it's the hand dealt to the companies, but you can choose where to invest into, that's the issue. anyway, I am aware of the commercial complications as I am on the sell side. it's the buy side guys I had the chance to work with that left me puzzled (all of those very focused with the micro / sector picture)

thebrofessor:

also, it's not all that useful in my opinion. what would your report say? well Visa should continue to execute on its core strategies, but we're forecasting a 30% drop in equity prices and a global slowdown so you shouldn't invest here. that would never happen.

that would be sound advice though :) well, when I looked at Volswagen long before the scandal (~ march 2015) where its validity as "value play of the century" was widly discussed, I just saw a company with massive exposure to china (on which I was bearish for a variety of reasons - and no I didn't pull the trigger because I was / still am too green and dumb) at a revenue and, mostly, at an EBIT level (~40% at the time). all I was saw was analysts debating about how the composition of the cars/SUVs/brands pitched against the ones of the competitors whereas I was wondering about the massive implications of all the stuff in china affecting the pockets of the consumers and the global slowdown. And no, I am not bragging about it because I was stupid enough not to capitalize on the opportunity. in essence: yes I'd have issued a report like that

thebrofessor:

3. valuation is everything. this is self explanatory.

again. I agree 100% with you. and, to me, it remains the greatest challenge (on top of all the other stuff I know / understand nothing about). I mean when I look at a company / sector trading at 13x P/E I ask myself: and why not 14x, or 12x? there's always the unrelenting feeling i'm riding some bubble of which I am unaware of and I have no control over

Feb 10, 2016

great thoughts. on volkswagen, what I've seen is analysts doing their normal fundamental analysis at a micro level and then building some macro thoughts into their bull/base/bear cases.

for example: using your VW example, base case would be malaise from lawsuits abates, global economy muddles through, bear case would include some of your comments about china, VW doesn't capitalize on the cheap gas dividend everyone is hoping for because most of those light vehicle sales go to ford f 150s.

I'm not saying it's not prudent, I'm just saying what often is the right thing to do is often outside the scope of the sell side analysts.

Feb 10, 2016

Getting "burnt" on what? Are you implying that sell-side analysts have skin in the game? You need to understand that equity analysts are fundamentally marketers.... impartial research is only on the buyside, or at small specialized shops.

Feb 11, 2016
giantdad:

Getting "burnt" on what? Are you implying that sell-side analysts have skin in the game? You need to understand that equity analysts are fundamentally marketers.... impartial research is only on the buyside, or at small specialized shops.

I know. also true that you can build credibility when you start to convey the message ("this is crap, do not buy it") in a subtle way. in my very short experience it kind of pays off. I had a big pocketed client to whom, though not clearly stated, I had ventilated some bad stuff was about to hit the fan. in that moment of course he did not buy anything (short term loss) but when I told him that another pick was good for X,Y,Z at a later time he jumped right in with 3x the capital. I know I might have been (i) lucky (ii) a set of circumstances out of my control blessed me (iii) anything else but I like to think that, to some degree, I was valued for my honesty (off the book) and it paid off.
that being said 70% of my ratings are buy and same percentage applies to my firm.

Feb 10, 2016

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