Portfolio Management: How To Add Macro To Your Process

This is a transcript of a conversation between Jeff Black, VP of Content and Education at Tornado, and his guest John Normand, in March 2023.

John is a cross-asset strategist who spent over 25 years at JP Morgan heading research for foreign exchange, international rates and commodities. He was also head of cross-asset strategy. The following is not investment advice and all views John expresses are his own.

On how to apply macro to investing: The simplest process is three-stage.

First, I examine a market’s long-term valuation to determine whether it is expensive or cheap from a long-term perspective. Simple valuation indicators like a price-earnings ratio tend to be mean-reverting over the long-term, which means that periods of very expensive valuations tend to be followed by periods of cheap valuations. Knowing where an index like the S&P or a sector P/E for Energy, Energy Select Sector SPDR Fund XLE or Financials, Financial Select Sector SPDR Fund XLF sits relative to 20, 30 or 40 years of history gives some indication of how sensitive a market will be as the business cycle evolves.

Second, I characterize the current macro environment as being one of four regimes: (1) early-cycle expansion, which is the first year after the recession; (2) mid-cycle expansion, which is the next two to four years; (3) late-cycle expansion, which is the last year before the recession; and (4) recession.

Based on the historical relationships between how markets and sectors perform in each of these four phases, I can formulate a baseline view on where to allocate. I spend a lot of time quantifying these historical relationships between the economy and markets, and adjusting them for circumstances that may have changed over time.

Third, I adjust positions (taking profits on winners, and rotating into losers) as prices move relative to macro fundamentals.

Five key things investors should know about macro:

1) What investors sometimes characterize as company fundamentals are heavily influenced by the macro economy.

2) The macro economy is dynamic rather than static, and includes phases that are huge accelerants to returns (the early cycle recovery just after a recession) and that are also harmful to returns (a recession). These phases matter for anyone who needs liquidity in horizons of under one year.

3) Investors should run the numbers to quantify these relationships between the economy and markets. I guess there are shortcuts and rules of thumb, but I don’t have full confidence until I have graphed dozens of relationships and at least run some basic statistical exercises like correlations.

4) If I had to watch only one macro indicator, it would probably be the monthly ISM survey. The level and direction say a lot about how well or poorly the economy is doing.

5) Finally, listen to the Fed. You may disagree with what they are saying or doing, but they control the price of money over the short to medium term. Think of them like company management — you need to listen to how they intend to manage, or else you could be blindsided by the consequences of their decisions. Invest 30 minutes every 6 weeks to listen to the Fed Chair’s post-meeting press conference and Q&A.

You can find the original audio / blog, and a range of others, at Tornado.com

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