When you ask a stockpicker about their view on the economy, inflation, trade wars, etc, the most common response you’ll get is “I’m not a macro guy (or girl); I just focus on finding the best businesses and owning them at reasonable valuations.” Most stockpickers have a somewhat limited understanding of macro and geopolitics, and for good reason; to the US investor, these things really haven’t mattered for the last 30 years, and you could make the argument that they haven’t really mattered since World War II. Throughout the Great Moderation of the last three decades, GDP growth has remained steady (though slow), inflation has stayed in check, and interest rates have pretty much only gone down. It’s pretty much the best macro backdrop you could ask for as an investor in any US asset class, so it hasn’t paid to worry about macro; every time there’s a crisis, just buy and you’ll be fine.
I have a feeling though, that macro is going to matter more and more. Sure, no matter what happens in macro, the best businesses will do better than the worst ones. But given where valuations are and how much they’re supported by low interest rates, you’re making a macro call by owning any US equities, like it or not. If the 10Y goes to 5%, stocks are objectively overvalued right now. If it stays where it is, stocks are fairly valued and maybe even undervalued right now.
That’s why I decided to read Geopolitical Alpha by Marko Papic. I wanted to educate myself a bit more on macro. The book was actually quite good — I would recommend reading it in its entirety, but I’ve written about some of the main takeaways below.
Papic starts out by making an argument similar to the one I made above: historically, macro only mattered to EM and FM investors, but now it’s going to matter to everyone. He argues that the Great Moderation of the last 30 years “was actually underpinned by globalization, massive expansion of the global labor supply, adherence to laissez-faire policies, and global stability enforced by American hegemony” as opposed to better central bank policy, which is the mainstream POV. He thinks that these underlying factors are changing (i.e. the electorate wants to deglobalize, wants to move away from laissez-faire, and America is less financially able to enforce global stability), which means more macro volatility.
So how do you make macro calls? Well, as policymakers make decisions, they have preferences (what they want to do), and constraints (the bounds placed on them by politics, the economy, geopolitics, and legality). Papic’s main idea is that “preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.” In short, focus on constraints over preferences. This approach helps to sift through a lot of the noise you see in the media, which tends to write stories centered around the preferences of decision-makers (think all the profiles on Donald Trump, Boris Johnson, Narendra Modi, etc).
Seems intuitive — but how do you figure out what the constraints are? One approach is the Median Voter Theorem. The idea is that to determine the long-term trajectory of a country’s policies, look at what the median voter wants. The median voter is the political constraint on policymakers.
The US today is a good example. Historically, US economic policy was governed by the Washington Consensus, which is a general set of principles around fiscal prudence, free trade, limited government intervention into the economy, etc. Papic argues, however, that the median American voter has shifted much farther left on economic issues than most people realize as a response to rising inequality and stagnant wage growth over the last few decades. This is what opened the door to policies like helicopter money and stimulus equating to almost 30% of GDP during Covid, which would have been considered “socialist” a decade ago. Yet, the American voter still wants more, and policymakers will give it to them — when you consider it, more government involvement in the economy is something both the far left (Bernie) and the far right (Trump) agree on.
Put more simply, politicans have discovered that handing out money to the public is an easy way to garner public support, and politicans on both sides of the aisle will want to take advantage of this fact. The genie is out of the bottle. Both of Biden’s $2tn infrastructure plans have 60%+ public support, and Senate Democrats are talking about a $6tn budget.
You might ask: if stimulus checks are such an easy way to get votes, how come US politicans didn’t do it earlier? Historically, with a few exceptions like the Great Depression, every generation in the US was better off than the one before it. As such, it was much easier for the electorate to be aligned to Washington Consensus-type principles. The country was also younger and less wealthy, and fiscal prudence was a greater part of the national psyche. Now, after 30 years of close to zero real wage growth, middle class Americans are angry. As such, the fiscal stimulus we’ve seen in the last year is likely just the beginning. Papic writes:
Over the next decade, I would expect more unorthodox fiscal and monetary policy, an increase in antitrust cases, further fiscal easing, selective regulatory pressures, and higher taxes on both capital gains and high-income taxpayers. If you’re fretting about the extraordinary fiscal cliff coming up in 2021, don’t. Policymakers will assuage it with even more fiscal stimulus.
There’s this big debate going on as to whether the inflation we’re seeing right now is transitory. I think it’s a moot point. This current bout of fiscal stimulus may or may not be permanently inflationary, but I can almost guarantee you that politicans will continue with deficit-financed fiscal stimulus until something bad (i.e. inflation) happens. If the Fed fights them by raising rates, they’ll just go further. They’ve been given a mandate to do so by the median voter.
What I don’t know is the exact timing of this. It will depend on more short-term considerations like the 2022 and 2024 elections, President Biden’s ability to push his various economic policies through Congress, and the exact capacity of the US economy to handle all this money printing, which has been larger than I think anybody expected. But over a 10-20 year time horizon, I am not bullish on the dollar.
This brings me to the next point from the book, which is to think in terms of long-term themes instead of day-to-day events. A friend was recently telling me that “the 2024 election is going to be the most important election to the country’s future.” People were saying similar things about the 2016, 2018, and 2020 elections. I broadly disagree, though. These outcomes might matter in the short-term — but on economic issues, the country is on a long-term leftward treadline, and no particular election will change that. An individual election may take us temporarily above or below that trendline or change the timing, but it won’t change the underlying currents that I mentioned above, unless said election results in significant structural reforms, which I think is unlikely. By the way, populism has been a common side effect of economic strife throughout human history — the way to fix it is by solving the underlying economic issues that voters are angry about.
There are a bunch of other interesting case studies Papic goes over in the book — the Greek debt crisis, Brexit, the US-China trade war, his outlook on India, US-Iran relations, etc. All these case studies made me better understand why macro is so hard — as opposed to trying to predict the outlook of a single company, you’re trying to predict the outlook of an entire country. Complexity increases exponentially with size. The other thing that’s hard with macro is timing, because a lot of macro bets are levered (FX trades, carry trades) so even more than long-only stockpicking, you need to have a really strong sense of timing in addition to making the right call. The upside of macro is that if you’re good at it, you can scale up your strategy far more than an equity strategy, since FX markets are so large and liquid. It’s no surprise that the largest hedge fund in the world, Bridgewater, is a global macro shop.