Notes, Views, and the Occasional Provocation November / December 2015 

Most investors assume that "macro" events such as the Federal Reserve's interest-rate decision today or the Paris climate agreement last week play a large role in determining investment returns. But some of the most successful investors say they spend little time on the grand economic picture when making portfolio decisions.

They know how difficult it is to glean any actionable information from the big picture and how dangerous it is to pretend otherwise. As Mark Twain noted, "It's not what you don't know that gets you into trouble, it's what you know for certain that just ain't true."

I hope you have a happy holiday and a smooth ending to the year.

Best regards,

Milo Benningfield




When It Pays to be Self-Absorbed
We're often admonished not to lose sight of the "big picture." But when it comes to taking care of ourselves financially, it's the smaller things over which we have the most control that can have the biggest impact. more


When It Pays to be Self-Absorbed

We're taught early in life to "think big," and we value leaders who can see the "big picture" and "not miss the forest for the trees." At the personal level, we admire people who are "broad-minded, which is why Ernest Hemingway could land a punch by supposedly calling his hometown of Oak Park, Illinois a "land of wide lawns and narrow minds."

In economics, the big picture is called "macro" and concerns things like national growth rates, currency movements, and aggregate supply and demand. Microeconomics, at the other end, focuses on supply and demand for a specific product, or the production capacity of an individual business. When we worry over whether Greek debt will topple the European Union, we're worrying over macro. When we debate where Chobani Greek yogurt sales are going next year, we're talking micro.

It's the big, macroeconomic stories that drive the business news and make the headlines, especially since, far more than micro, they lend themselves to "narratives" and "themes," and we all enjoy a good story. As a result, most people think that macro events determine investment results, and pay a lot of attention to news such as the Federal Reserve's decision this week concerning interest rates or last week's climate agreement in Paris.

These are important announcements, to be sure. But it's striking how some of the most successful investors have gone out of their way to declare how unhelpful the macro picture is to their investment decisions.

Earlier this year at the Berkshire Hathaway annual meeting, Warren Buffet's business partner Charlie Munger said it was best to declare yourself ignorant about macro forecasts and that he and Buffet prefer to "keep swimming and let the tide take care of itself."

Peter Lynch famously said that trying to guess when the next recession would hit was a fool's errand, "[s]o I don't worry about any of that stuff. I've always said if you spend 13 minutes a year on economics, you've wasted 10 minutes."

When concerns about Europe's economy were paramount a couple of years ago, Oaktree Capital's admired founder Howard Marks was asked what he thought would happen there. He said the situation was complex, but that he was sure of three things:

  • He didn't know what would happen in Europe.
  • Nobody knew what would happen in Europe.
  • If you asked an expert what they thought and took their advice, you'd be making a mistake.

Marks' honest take on a complex situation is usually the last thing nervous investors want to hear when stock prices are falling. So instead, the media looks for and publicizes simplistic links between cause and effect, with sometimes-humorous results.

In June 2014, for example, with oil at $110 a barrel, the financial headlines blamed rising oil prices for falling stocks. Six months later in December, they said just the opposite, blaming a stock-market swoon on falling oil prices. As financial blogger Josh Brown noted at the time, the only obvious conclusion about the financial media was, "They're all making it up. They're watching market prices fluctuate and assigning meaning where none exist."

Often it's just a matter of looking at the data to unmask an overly simplistic macro view. Take the Federal Reserve's interest-rate decision this week. Conventional wisdom tells us that rising rates are bad for stocks, since higher borrowing costs can inhibit corporate growth and since higher rates suggest lower stock prices in a variety of valuation models.

But if we look at actual experience with the S&P 500 Index over the past twenty-five years, we see that it actually gained more during periods of rising rates than in periods of declining rates. Thus, rising rates cannot, by themselves, tell us whether the stock market is going up or down.

The harder cases are where the macro data is so complex that they can support just about any position, as with climate change. Some models suggest that rising temperatures of approximately two percent Celsius could enhance investments in everything from emerging markets, infrastructure and agriculture. But if temperatures rise closer to four percent Celsius, those same investments could be doomed. Given the magnitude of uncertainty involved, we're better off throwing up our hands like Munger and Buffett rather than trying to act on wild guesses.

This is not say that we should completely ignore the macro environment in making investment decisions. In figuring out which risks are worth taking, it's helpful to look at the bigger picture and study how assets behaved under different scenarios. But the time to do this work is up front, during the portfolio-construction process, not when another adverse event happens. We should build our boats before the storm, not as we're riding through it.

Apart from that, we'll find the most opportunity by directing our attention away from the big picture back to ourselves. Instead of "macro," we should look to our personal economics and reap a double benefit by focusing on things over which we have more control and filtering out the financial noise permeating the air.

For individuals, questions such as "Did I hit my savings target, or stay within my spending range?" are far more useful than "How's the market doing this year?" Hitting small goals consistently such as funding retirement accounts and maximizing tax deductions each year adds up to big results over time, greatly enhancing whatever returns the markets deliver.

But the surest way to balance out macro risks and regain control in an uncertain world is by shoring up our personal economies and staying disciplined over time with financial decisions. We may not be able to foresee the next stock market crash, but we can set aside sufficient cash reserves to weather it. We may not be able to predict the next flood or earthquake, but we can purchase insurance for these perils.

In the end, buffering ourselves from the larger macro events of life is as simple as a trip to the airport. We can't control the traffic on the highway, the baggage line, or security at the gate. But we can estimate how long these things will take under normal circumstances. If we want to protect ourselves against surprises, save ourselves frustration, and increase the likelihood that we'll make our flight, we can build a buffer and leave a little early, enjoying extra music along the way. How early we leave, of course, is up to us.

Thank you for reading. Please look for our next newsletter in February.

Best regards,

Milo Benningfield

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