HOW I APPROACH THE CHANGING MACRO INVESTMENT ENVIRONMENT

I get a lot of questions regarding my actual approach to portfolio management so it’s useful to elaborate on the way I view the macro investment world.  The attached diagram shows my overall approach.  I use what is called a top down approach.  This means that I formulate a big picture view and then apply money making strategies to that overall macro outlook. This is different from a bottom up approach in which investors try to find pockets of the market that are mispriced while ignoring the macro picture.  They assume that markets will adjust over time and reprice the mispriced asset to reflect its true value.

Formulating the macro picture is largely what you read here at Pragmatic Capitalism.  There are a huge number of variables that go into this formulation.  What is the government doing?  Where are earnings going?  What are the inflation/deflation trends?  How is the global economy impacting the markets?   A great deal of understanding and education is required for this sort of approach.  If you don’t understand how monetary systems work you probably won’t understand where interest rates are headed.  If you don’t understand where interest rates are going you won’t know where bond prices are going.  So on and so forth.  Markets are highly interconnected.  If you don’t understand the bond market I would venture to argue that you probably understand the stock market less than you think.

All of this analysis results in some sort of macro outlook.  Currently, I believe we are in a long lasting balance sheet recession that has caused a secular bear market in stocks.  High debt levels have resulted in extreme excesses and the bursting of this debt bubble has resulted in private sector balance sheet implosion.  The recovery period out of this recession will involve below trend GDP growth, low historical inflation and a generally difficult investment environment.

Once I’ve formulated the macro environment type I can begin to apply specific investment approaches.  As I often say, I think it’s important to remain flexible.  I am not against using a buy and hold strategy or any strategy for that matter.  I just know that there is a time and a place for specific strategies.  Buy and hold does not always work.  With the exception of a brief window in 2009 when everyone was saying distressed debt was too risky and buy and hold was dead (I was saying the opposite at the time – see here & here) this has remained an environment in which traditional long-term value oriented investing strategies have resulted in low risk adjusted returns.

Next I can decide which of my strategies to apply to this macro outlook.  Because the choppy macro outlook leads me to believe short-term strategies will produce higher risk adjusted returns I have to reach into the trading toolbox.  I always use a multi-strategy approach.  The key here is that I have several short-term or medium-term strategies working all at once.  While I have my favorites the multi-strategy approach ensures that I am never pigeonholed.  If the opportunities in one strategy appear favorable I can allocate more of my overall approach to that strategy.

Within each strategy I have specific approaches.  Some of this is actually elaborate bottom up investing, but varies enormously from strategy to strategy.  Running this sort of platform requires an enormous amount of work and research, however, I have come to believe that it best suits my needs and has helped me to produce high risk adjusted returns over a sustained period.  Every investor is different, however, having a detailed process in which you work is necessary for investment success.  What you see here at Pragmatic Capitalism is largely the first step in this process – the macro outlook.  This is probably why I appear to have a bearish emphasis most of the time.  This is true only at the macro level.  As a risk manager I think it is important to focus more on the potential dangers.   Within this macro outlook I have been and will continue to be wildly bullish at times in a micro sense.

So there you have it.  That is my flexible, multi-strategy, global macro investment approach to a tough investment environment.

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. i knew there was an intrinsic reason i come here after email and weather.

    this is basically the flow chart i have been intuitively using from the start.

  2. Cullen,
    Great commentary…Thanks….So, if most of us don’t understand how to interpret the macro picture, would you provide us with a list of resources where we can learn? i.e. the monetary system, interest rates, the bond market, etc.?

  3. This is an excellent overview of a useful approach to a macro driven investment strategy.

    It meets the test of time, and therefore should not be allowed to disappear into the bowels of PragCap’s web site, rarely to be seen again..

    Perhaps PragCap can retain it in an easily accessible location … say, via the Tools & Resources dropdown, as is being done with What’s on Tap.

  4. “If you don’t understand how monetary systems work you probably won’t understand where interest rates are headed. If you don’t understand where interest rates are going you won’t know where bond prices are going. So on and so forth. Markets are highly interconnected. If you don’t understand the bond market I would venture to argue that you probably understand the stock market less than you think.”

    Based on the average returns generated by the money management community over the past decade, I’d say this comment not only applies to the majority of individuals, but to professional investment community as well (present company excepted, naturally.)

  5. Gator,

    I read TPGs column today and was dumbfounded as are many others, it seems.
    This is a smart, intuitive and the best sort of critical thinking. I’ve been advising clients for years and have never stooped to a formulaic, rigid approach. This does a superb job of capturing a strategy with legs.

    My suggestion is read, read, read. Then, read some more. Things continually change a la Keynes.

    I have an increasing list of favorites with the like sof Martin Wolf and John Authers. TPG is always a touchstone as is Yves Smith.

  6. Gator,

    I get this question so often and I never quite know how to answer it. As TJGPDX said you just have to absorb as much material as you can. I have read mountains of investment material and there is no holy grail. You just have to absorb it all and come to your own conclusions. I try my best to provide a nice broad overview of many things, but there is simply too much to cover.

    Off the top of my head this is a pretty good place to start for understanding the system: http://wfhummel.cnchost.com/ but there is much more to it than is described there. Much more.

    As for investing I think you need to find what suits you. There are so many approaches and we are all so different. It’s impossible to apply a single approach.

    Not the answer you were looking for I know…..

  7. Will put it in the best of section so it doesn’t fall into the black hole of lost articles….Thanks Shippy.

  8. Yes. Just look at mutual fund guys. We have large cap tech funds and small cap value funds and everything inbetween, but what these guys don’t seem to get is that they are all interconnected in many ways. Thus why we see such a high correlation between most mutual funds and their correlating indices. They’re mostly just mirroring some macro picture that they aren’t trying to differentiate themselves from.

  9. “If you don’t understand how monetary systems work you probably won’t understand where interest rates are headed. If you don’t understand where interest rates are going you won’t know where bond prices are going. So on and so forth. Markets are highly interconnected. If you don’t understand the bond market I would venture to argue that you probably understand the stock market less than you think.”

    TPC
    I think you should add a caveat here for the reader.

    Caution: I TPC am an advocate and supporter of the MMT model of monetary systems.

  10. TPC

    If your views on MMT were to be proven wrong or flawed then your macro view could be seriously distorted.

    Would you agree with that statement?

    Your macro view has a lot riding on MMT.

    Thats all I’m saying.

  11. MMT is easy to disprove logically

    It assumes totally circular financing with the only caveat that “inflation” could be a danger, of course inflation cant be a problem under MMT because the money never goes anywhere and remains ones and zeros on a bank/government computer server somewhere.

    You guys have created a theory whereby we can never default, the currency can never be depreciated, we don’t have to pay our bills and can run them up virtually indefinitely with willing suckers on the other end buying our debt perpetually………….or not…..because under MMT we dont even have to issue debt right?

    Its debt without consequences

    Its credit without consequences

    It defies history, what do you have, a 20 year data set from Japan to use as an example and this singular data sets trumps all of history?

    MMT is a free lunch

    Its hyperkeynesianism

  12. “Do you happen to know someone who thinks they have found a hole in MMT?”

    Well, as Sir Karl used to tell us, there are only two kinds of scientific theories, those have been falsified and those have not. Because any theory can not be true without assumptions.

    Not saying Austrian is superior but in next decade or so what we will see is those free lunch theories are going to be falsified. Modern welfare states will fail and there is no perpetual inflation people will tolerate.