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The macro picture

It is said that the camera never lies but Nicola York finds that taking a macro snapshot of an economy could give a false picture of the state of the stockmarket

When looking at countries to invest in, is the macro-economic picture really an indicator of stockmarket performance? Or should you be looking at other factors such as liquidity conditions and how the market interacts with other markets?

Credit Suisse joint head of multi-manager Gary Potter says on certain occasions there are big deviations between the economy and the stockmarket, citing Germany as an example. He says: “The economy appeared to be on its knees in terms of GDP growth but lots of restructuring has gone on behind the scenes and the German market has done very well.”

Potter says it is perhaps not so relevant to focus solely on the macro-economic outlook over shorter periods of time. He believes there is a distinction to be made between the emerging world and the mature world. “I think there is a much better correlation between the development of an economy and the stockmarket in an emerging area and less correlation between the two in the Western world,” he says.

Russia and Brazil are two examples where Potter says it has been important to look at the macro-economic picture. He thinks it is particularly relevant to understand what is happening in terms of foreign direct investment, improvements in balance of payments, balance of trade, whether inflation is being curtailed and the control of central banks in emerging markets.

Europe and the US are examples he gives of the strength of a country’s economy not reflecting its stockmarket performance. Potter says the US economy has been outperforming the European economy in terms of growth for a number of years, with an annual GDP of around 3.5 per cent compared with forecasts of below 2 per cent for Europe. But he says the US equity market has underperformed for a number of years whereas Europe has seen good performance.

Best Invest research analyst Marcel Porcheron thinks there is often no correlation between stockmarket performance and the economy although, if the macro-economic environment is not good, it can impact on company earnings. But he also thinks it depends on which stocks are concerned. For example, cyclicals would be leveraged to changes in the domestic economy, he says.

Seven Investment Management director Justin Urquhart Stewart prefers to look at the dynamics of a market and how it has behaved in correlation with other markets. He says some indices are relatively small in terms of numbers of companies, so it does not take much to skew an index if one company is doing better than the rest.

He also thinks a lot of indices – particularly in the eurozone area – are related to exporting companies and therefore their stockmarkets have been doing well, des- pite their domestic economies performing badly.

Another element, according to Urquhart Stewart, is that equities are trying to discount 12 to 18 months ahead. He says: “You would have to say, when you are looking at some of the markets, they are discounting it the wrong way. If anything, you should be going down and not up.

“The normal elements when you are looking at an index and wondering why it does not bear much resemblance to the country are to do with forward indication.”

The UK is a good example of the dislocation between the economy and the stockmarket, says Urquhart Stewart. He says the FTSE 250 should be doing badly because its performance is correlated with the UK economy. He says: “The mergers and acquisitions froth is keeping it going but, if you look at the earnings expectations of the FTSE 250 and smaller companies, they are going down and not up. So it is a false market at the moment.

“The more underdeveloped a country, the more speculative is the market and, therefore, the more dangerous it is when you are trying to actually read into the strengths of the economy.”

He says India and Malaysia are good examples because they are seeing growth in their domestic pension savings, so have more money to invest. Therefore, the economies are seen to be growing but their markets are still very speculative because inward investors are looking to make short-term gains there.

New Star investment strategist Simon Ward thinks there is a correlation but “not in the way that most people look at it”. New Star focuses on liquidity conditions in different countries and uses excess money growth as a key measure of liquidity. Excess money growth is the difference between money supply growth adjusted for inflation and economic growth. He says: “The idea is that if the money supply is growing faster than economic output, then there is an excess which can go into financial markets.”

He cites Germany as an example of where the liquidity approach has worked. Although economic growth has been weak recently in Germany, he says money supply growth has been stronger, which has led to “tonnes of liquidity” being injected into the stockmarket.

But there are instances when the theory is not successful. “There are occasions where earnings developments will swamp the liquidity backdrop, so if an economy goes into a recession, then liquidity will look great but earnings are being decimated. In that situation, the liquidity tends to go into the bond market rather than the stockmarket,” says Ward.

China is another example that Ward uses to illustrate this point, saying the performance of domestic Chinese stock has been “disastrous” but the economy has been booming. He says: “This is another example where the liquidity environment has been negative because of strong economic growth, so you have not seen the strong growth reflected in the stockmarket.”

Nevertheless, he feels that the prospects for Chinese domestic stocks are improving because money supply growth has been accelera- ting this year and is almost on the point of moving above economic growth.

Ward says despite the UK’s economy performing disappointingly, there is a huge gap between money growth and output growth because money supply growth has accelerated to over 10 per cent year on year. This has benefited equities and bonds and he thinks the residential property market is starting to improve again as a result of this.

Aberdeen Asset Management head of pan-European equities Chou Chong says investors need to bear in mind that the FTSE All-Share index is a poor indication for how the UK economy is performing. Chong says: “There is a tendency among commentators to write off the prospects of UK equities. The economy is said to offer only limited growth prospects and is far too exposed to an over-leveraged consumer. But I would advise investors not to be beguiled by these bearish stories.

“The UK is home to many well-run companies, with opportunities at home and abroad to create and return real value to shareholders in the long term.”


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