Business Cycle: Our Macroeconomic Approach

We divide all economic information into three broad categories: (i) measures of monetary conditions, describing the movement of capital through the real economy and markets; (ii) economic gauges, which are generally based on backward-looking, survey-type information; and (iii) price gauges, which track the inflationary factors effecting businesses and consumers.

Within each category a handful of actual data series provides the starting points for analyzing long/short equity and fixed-income investment opportunities. Then we back-test the impact of each economic data series on hypothetical market portfolios, to measure how these series have impacted the market in the past and at what parameters the relationship between forward-looking market returns and the economic data has been strongest.

Like the optimal portfolios, the regression analyses have been iterated to determine over which time periods the economic data best explains (or is most correlated with) future benchmark variances, so that we come away with the best possible understanding of how current economic news should impact our expectations of future market prices.

Finally, the inherent complexity of a national economy cannot be reduced to simple rules. Rather, the expectation is that some portion of the fundamental relationships between macrofactors and the market will obtain over time, and that it is better to understand these relationships themselves than not. With this in mind, we discuss the relevance of each data series to our understanding of the current economic cycle and investment climate.

And we must always keep in mind what business-cycle, market-timing, and global-macro investors have been learning for decades, and frequently forgetting: That an understanding of the business cycle and the role that various investments play within that cycle is the beginning of wisdom. It may not on its own constitute either a comprehensive investment strategy or one that is guaranteed to be profitable.

John Maynard Keynes, the British economist, started his investment career believing that an understanding of the business cycle would be the path to riches. That turned out not to be the case.

—-Chancellor, Edward and Martin Hutchinson. “Keynes’s Other Hypothesis.” The Wall Street Journal, 3–4 February 2007, eastern ed.: page B14.

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