The past yr has been humbling for economists and investment strategists alike. It began with an “impending” recession and ended with the stock market near all-time highs.
Historic rate hikes fueled a compelling narrative that, at best, foreshadowed each a weak economy and disappointing returns. Of course, there have been legitimate concerns underlying this narrative. Post-COVID-19, the world was still at the tip of an era of “unprecedented everything” amid resurgent inflation. But the inherent pressure to take a stand on economic developments led many investors to seek out comfort within the collective concern and embrace the prevailing narrative.
For many investors, human nature took over.
So what can we learn from this scenario?
Investors crave a compelling, rational narrative. Economic data that’s more detailed and accessible than ever before helps us present these narratives.
But with large amounts of information comes great responsibility. Not only do we’d like to maintain our beliefs, goals, and time horizons in perspective; We must also do not forget that economics and financial markets are usually not the identical.
It’s easy to forget that.
In the rational, well-ordered world of economic theory, various pieces of economic data fit together like a puzzle, illustrating the ever-evolving interplay between businesses, consumers, investors, governments and central banks. Of course, in point of fact, these data are sometimes delayed and revised and have various and evolving impacts on financial markets. Additionally, this data is usually chosen for clickbait headlines and political talking points.
And with economic forecasts changing with the wind, investors are finding it difficult to realize clear, actionable insights.
So what should we do?
The economy deserves due attention, but we should always not allow it to steal the highlight. Financial markets themselves offer significant insight.
Here are five inquiries to ask to higher understand the markets without having to invest concerning the broader economy:
1. How has the market composition developed?
What forces are at work beneath the surface and are causing turmoil within the financial markets? How concentrated are market capitalization weighted indices? How have sector weights adjusted over time? Which stocks are newly listed or outperforming the market cap and elegance spectrum?
To understand the recipe we’d like to know the ingredients.
2. Which firms contribute to the result?
Do markets lend where appropriate? Comparing a stock’s earnings weight to that of its market capitalization shows what’s moving the stock and whether that move is temporary or sustainable in the long run.
A more in-depth take a look at earnings trends across sectors, sizes and aspects provides critical context that superficial data simply doesn’t provide.
3. Which stocks contribute to returns?
Stock prices reflect the collectively evolving opinions. What do investors reward? Basics? Stories? Narrow or broader market segments? Does 360 degree evaluation support these returns going forward?
The past yr presented investors with quite a lot of puzzles. The “The glory seven” has driven the S&P 500 higher for a lot of the yr. But should we at all times expect a handful of players to hold the team? Proactive risk management requires that we understand the source of our returns.
4. What do the “basic specifications” say?
Just as doctors make their diagnoses after a series of tests and examinations, investors must do the identical. A cursory examination of market data is just not enough to offer sufficient context. We must know what is going on on beneath the surface.
“Fundamental technicals” are crucial indicators of the underlying health of economic markets. They measure what’s really occurring under the hood.
Market breadth, relative strength, put-call ratios, equal-weighted indices and volume, amongst other things, can provide insight into risks and opportunities.
5. Where do wealth flows go?
Expressing an opinion concerning the market is one thing, but committing actual investment capital to that thesis is kind of one other. Do we have now the courage for our convictions?
Wealth flows measure the consensus in addition to the extremes and outliers. They reflect real decisions with real consequences. From a behavioral perspective, the emotions they reveal might be each entertaining and insightful.
Diploma
The economy is essential, but it surely matters in another way to different investors depending on their different goals, timelines, and asset allocation. And it is not the one thing that matters.
As humans, we have now an innate tendency to group think. The more we follow the headlines, the more our own perceptions correlate with them, drawing us away from our investment process on the very moment when it’s most significant to keep on with it.
Ultimately, we should have the discipline to rework our evaluation into actionable insights. We must always ask ourselves: “What does this mean in the context of my strategy?”
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Peter Hansen
