Jan 09 2017
Lawrence Lam

Performance of the overall economy – why it’s irrelevant to most investors

Macro predictions about the performance of the economy or specific industries have limited value to us – we invest in specific businesses, not economies.

Lower risk and higher returns can be made from finding quality businesses in out-of-favour industries.

We invest in businesses, not specific industries or economies. Broad economic predictions have limited value to us

With the start of the new year, experts have put forward a bunch of financial predictions for the next 12 months. Where will the ASX 200 be at the end of the year? How will the property market behave? Will the Australian dollar be much lower than its current levels? Which sectors will outperform this year? Will small caps beat large caps again this year? To us, these are difficult questions that we don’t have the answer to. We have found the expert analysis an interesting read, but not something we are prepared to invest our money in. The poor track-record from the experts demonstrates exactly how difficult it is to correctly predict both the magnitude and timing of financial markets. For instance, ABC’s The Business has an annual review of economic predictions, pitting experts against students – more often than not, students come out on top: http://www.abc.net.au/news/2015-12-04/student-economic-predictions-humble-professionals/7002196.

Not only are the predictive arts extremely difficult and unreliable, we question its usefulness. We invest in stocks, not the overall economy or specific industry sectors. A prediction on the Australian economy, even if it is correct, only informs us of the overall average performance of all stocks, not a particular stock. In sporting terms, a correct prediction for the average time for all swimmers in a race still doesn’t help us predict which swimmer will win that race. We believe in studying the merits of each business objectively without the influence of market sentiment. We have found it useful to have this independent, unbiased foundation to our analysis.

Broad economic predictions inform us of market sentiment – we can use this to our advantage.

Broad economic predictions inform us where the market’s attention will likely be. Quality businesses at fair prices are less likely to be found in industries predicted to boom. Conversely, the market does not focus on out-of-favour industries – this is an ideal environment to find quality businesses at fair prices. We have found that the likelihood of finding a diamond in the rough is greater in these out-of-favour industries. For example, some of our best investments have been in finance businesses following the GFC.

As the pundits continue to issue economic forecasts (and subsequent revision updates that will inevitably follow) we will continue to focus on the main game – the merits of each individual business.

Further reading which may be of interest: