Business Cycle: Introduction

The fundamental premise of Stracia’s approach to macroeconomic analysis is that, to a certain extent, the forces driving company and industry performance over broad segments of the economy are foreseeable, even predictable, within the context of the business cycle.

And because the machinations of the economy, more than any other set of factors (e.g., company-specific or other nonsystematic factors) determine the long-term returns of equity benchmarks, an investor does not have to follow a rigid sector-rotation strategy to benefit from an understanding of these cycles.

Stracia seeks to equip (i) active managers with the tactical tools for managing risk exposure and the timing of entry/exit decisions, and (ii) passive managers with strategies for framing long-term investment policy decisions, as well as tools for managing periodic portfolio rebalancing.

…what are the different circumstances which sometimes raise some or all of these different parts of price above, and sometimes sink them below their natural or ordinary rate; or, what are the causes which sometimes hinder the market price… from coinciding exactly with… [its] natural price.

—-Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Ed. Edwin Cannan. London, Methuen and Co., Ltd.: fifth edition, 1904.

Macroeconomic analysis is the foundation for constructing comprehensive portfolio management strategies. It may also be the most daunting component of strategy-building due to the sheer amount of information involved——including anecdotal and survey-based series, variables that are subject to future revision, and time-lags.

In addition, the framework for interpreting macroeconomic data often depends on the interpretation itself (a feedback loop). While analysis of many key variables, such as the unemployment level, must be undertaken in the context of dominant business-cycle and market dynamics, our understanding of these dynamics is in turn based on the data being analyzed. Thus, the data tells us where we are in any business cycle, which in part and in turn tells us how to read the data.

Multivariate feedback loops are difficult to manage, and without a cohesive strategy the process quickly becomes unworkable. We thus need to bring some control to this, the first step of the strategy-building process.

The principal task is to decompose the macroeconomic landscape into manageable, meaningful components. In the table on the next page, we isolate those variables that have proven most significant in explaining past market performance, then build a framework for understanding the data at various points in the business cycle.

Next: Stracia’s Macro Approach »

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