insights

In a recent interview the host was astonished that I had little interest in the macro environment.

Unfortunately, I wasn’t able to recite Chris Mittleman (of Mittleman Brothers Investment Management), who explained why in his 2015 letter to investors.

‘There is [a] character out there, to be more ignored than taken advantage of; and that is Mr. Macro. Mr. Macro reads everything worth reading and knows every macro-economic indicator worth tracking, including the price of tea in China, and where the unsustainable imbalances are, and he plans to grab that next big asymmetric risk/reward payoff so The Big Short II will be about him.’

‘He even goes to Davos. He speaks of new normals, zero bounds, contagion, contango, unintended consequences, risk premia, risk parity, risk-on/risk-off, Abenomics, QE, BRICs, PIIGS, Grexit, Brexit, and Mr. Macro is the one who whispers in your ear at each sell-off, “Don’t do it… It’s different this time…” For long-term value-oriented investors like us, Mr. Macro is to be ignored with extreme prejudice. Because, as history has proved, opportunities for successful investment outcomes exist in even the most hostile macro environments imaginable.’

Pain of loss versus joy of gain

As fund managers we’re often asked about our outlook for the macro-economic environment. It’s understandable. Everyone wants to avoid financial apocalypses like 2009. Remember we feel the pain of losing money twice as much as we feel the joy of earning it. The average Australian doesn’t see episodes like 2009 as a huge opportunity (at least not in the thick of it) but rather something to be avoided, judging by the fall in individual stock ownership since.

Although we may feel strongly about certain economic outcomes, such as the future level of interest rates, these issues should only be as important as they relate to having adequate portfolio diversification and the individual investments you’ve made (i.e. could higher interest rates bankrupt a company you own).

Understanding a stock’s intrinsic value and the sustainability of its market position is much, much more important. As Mittleman says, ‘as history has proved, opportunities for successful investment outcomes exist in even the most hostile macro environments imaginable.’ Research consistently shows economic growth has little to no predictive relationship with investment returns.

If you’re waiting for GFC Mach II before buying another stock, you may miss out altogether. Who’s to say inflation doesn’t take off taking share prices with it as investors favour owning productive businesses over cash. 

Eight commandments for dealing with Mr Macro

Here are my eight commandments for dealing with Mr Macro.

1. Focus on the intrinsic value of the businesses you own. The further you think ahead, the less impact the state of the economy has on the value of your investments.
2. Understanding a company’s competitive advantage is critical. Good companies increase market share in a recession and emerge stronger than ever. Don’t let Mr Macro divert your attention from what really matters.
3. To buy a business very cheaply and make a large amount of money, usually the share price has to fall a long way first. See falling share prices as opportunities, not something to panic about, and be prepared for anything. As John Maynard Keynes said, ‘the market can stay irrational longer than you can stay solvent’.
4. Remember no one can predict the timing of recessions consistently, but a good fund manager can consistently identify undervalued stocks.
5. If you fear a financial judgment day, ask what you should do to relax. Usually those with the biggest fears either don’t understand their investments, or they have too much leverage. There are no new ways to go broke, it’s always debt. In fact, that’s why sharemarkets can fall so far. Much of the selling is to cover other financial liabilities, and has nothing to do with the intrinsic value of the businesses being sold.
6. High quality businesses always recover. An economic downturn is your chance to buy them cheaply. There’s a major difference between temporary paper losses, and permanent losses due to buying weak or over-leveraged businesses.
7. Never stop educating your clients about simple investment truths. You can measure your success by whether they give you more money to invest in a downturn or whether they’re selling out. There’s no point trying to educate someone gripped by fear. Being forewarned is forearmed.
8. Lastly, as the long-term owners of businesses we should welcome economic downturns. They clean out years of bad behaviour, make our economies more productive, and they provide the opportunity to earn high returns over many years during the recovery.

See market falls and recessions as opportunities

If we learn not to fear market falls and recessions, and see them for the opportunity they are, then we can focus on what really matters i.e. is each investment compensating me for the risks. For many companies’ macro risks are trivial anyway, and for others they’re insignificant compared to their ability to maintain and grow their market position.

Economist John Kenneth Galbraith opined that ‘The only function of economic forecasting is to make astrology look respectable.’ That said, it’s becoming increasingly obvious that Australia is over-doing it in the apartment space. If so, we may eventually join the union of countries with zero interest rates and the fall out may not be pretty. 

While everything is still calm, now is the best time to educate your clients. Have they got enough overseas exposure? Are debt levels under control if house prices fall 15%, 20%, or more? Is there adequate diversification? Have they written down their action plan to remove the emotion from their decisions and profit from any downturn? How would they deal with zero interest rates?

After a golden 24-year run for banks and property, lower interest rates may be causing more harm than good. The best defence is buying undervalued assets. Fortunately, markets are becoming more volatile, which means more opportunities to buy low and sell high. To harness the opportunities investors may need to be more active than they have been. Just make sure to let valuations guide you, not Mr Macro.

Nathan Bell is Head of Research at Peters MacGregor Capital Management @PetersMacGregor. For information about investing in our actively managed global portfolio, visit www.petersmacgregor.com.

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