If you spend 13 minutes a year on economics, you've wasted 10 minutes.However, despite the appeal of one-liners, macro environments do matter.
The macro environment matter because the macro environment is simply the aggregation of all investment decisions worldwide. Completely mapping these decisions and using the results for research is obviously not feasible, but since the price of an asset in public markets is what others are willing to pay for it, the “environment” in which an asset is priced is, by definition, important. The reason Peter Lynch and others have suggested not paying too much attention to the macro environment is that we only have 24 hours a day, and most people only have 5-6 hours of focused work. And in order to achieve attractive returns in the stock market that time is better spend analyzing companies bottom-up.
If we assume that an adequate mental or mathematical model of the macro environment takes into account distinct factors like bond prices in China, the US consumer index, and metal prices in Japan and everything in between, then yes, this doesn’t help you in a bottom-up analysis of your typical mid-cap. Attempting to tie everything together, unless you have the massive computational machinery required, would likely lead to analysis paralysis. However, the fact that something is intractable does not mean it isn’t there or doesn’t matter. A more practical approach to the macro environment is to understand how certain macro-level events influence the current public valuation of a given asset or security. A recent, potent example is the Covid era. The macro event of Covid sliced up the stock market into winners and losers. Companies like HelloFresh won, as fewer people dined out, and Roku won, as more people spent time streaming, and Block won, as people, battling boredom, turned to trading crypto from their home offices. On the other hand, some companies found themselves on the losing side: energy companies such as Glencore, BP, and ExxonMobil faced lower demands for coal and fuels; airlines like Delta Air Lines suffered from reduced travel; and car manufacturers such as Ford struggled with factory shutdowns and supply chain congestion. No one, except perhaps all-knowing conspiracy theorists, could have predicted Covid, but amid the global pandemic, any investor could ask themselves: Who are the winners and losers of this environment? And when the market consensus to that answer became visible in the stock prices, the natural follow-up question could be: Are current valuations due to event-driven, macro-induced trends, or are they an expression of the underlying business value, which is independent of those trends? Answering these questions is not impossible, and should be an integral part of any sound investment process.
Over the long run, investors who produce above average returns have a deep understanding of current market tendencies. They might indeed capitalize on those trends, but do not succumb to them. As self-sufficient as Mr. Market appears to be, he is nothing but the sum of current transactions by people and algorithms created by people. Asset prices are determined through group activity, and on average, groups tend to amplify reactions, just as many previous valuations, whether low or high, in hindsight, are easily recognized as overreactions.
Even the most renowned bottom-up investor of all, Warren Buffett, liquidated his private partnerships in 1969, pointing to the market environment in his May letter to partners:
I just don't see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grope around, hoping to "get lucky" with other people's money. I am not attuned to this market environment and I don't want to spoil a decent record by trying to play a game I don't understand just so I can go out a hero.History showed that Buffett did fine with his new investment vehicle that he started after the partnerships, but it was not in spite of the macro environment; it was because he analyzed it accurately. Opportunities for doing well in managing other people’s money soon arose, as the average P/E ratio of the environment that Buffett operated in, as expressed by the S&P 500, fell from 17.72 in May 1969, the month of his letter, to a low of 6.68 in March 1980. The 1970s proved to be a fruitful hunting ground for the astute value investor. While Buffett is generally perceived as a bottom-up investor who spends his time poring over scores of annual reports, he is also a significant proponent of understanding the broader economic context.
In this post, I’ve presented an argument in favor of considering the macro environment, especially when thinking about the valuation of a company, and I've provided anecdotal evidence that a well-known value investor has probably always given more thought to the macro environment than commonly viewed.