Fundamental Top-Down Macro for the Brain Damaged

Fundamentals have nothing to do with the market, brah.

Interior decorating is rock hard science compared to economics practiced by amateurs.

– Antonin Scalia (never actually said this)

Macro economic analysis can be pretty frustrating.  Many economists justify an attractive annual salary by coinciding, smoothing, and transforming the public into mass confusion.  The sheer number of data releases issued over the course of a year is rivaled only by the number of opinions as to the sensitivity of the economy to each data point.  This makes it nearly impossible for the casual observer or even market professionals to get on top of.  Most investors simply agree with the pundit that makes the most short declarative sentences.  The good news is that most of us already posses the most important skill set of macro economic analysis: the ability to squint.

That’s right, close your eyes.  Now open them up just enough to make out shapes and colors.  This is the correct way to look at any chart originating from a government agency or academic institution.  The data is always of questionable integrity and almost always subject to revision.  Not to mention the host of other statistical problems continuously pointed out and debated by super smart people on the internet.  The point is that you’re never going to see the whole picture in any one report.  All you care about is the general direction.  Most importantly, the general direction you can make out when squinting and glancing at a chart for no more than 3 seconds is the correct one.

I subscribe to the 80-20 principle which states that 80% of the results come from 20% of the causes.  This means that you can safely disregard most of the economic data published and just focus on the important stuff.  As far as I can tell most of the sentiment of the economy is captured in the metrics below (in no particular order).  Most of the data moves so slowly that the trend changes are obvious.

If you’re looking for quick trades and short-term actionable ideas, this stuff probably won’t interest you.  Macro analysis is the long-con.

Employment Situation

The Employment Situation report, or Nonfarm Payrolls as it’s more commonly known, is the single most important economic report — bar none.  It’s ability to move markets is undisputed.  It’s also the subject of more scrutiny and conspiracy theories than the Rothschild family.  Do yourself a favor and ignore all the idiosyncrasies of the calculation and the haters that point them out every month.  Not because the criticism isn’t warranted but because the report is all we’ve got and analysts pay attention to what’s in the report, not what isn’t.  You also have my full permission to look at only the headline number and the year-over-year change.  Sure, there’s a lot of insight that you can gleam from looking a little deeper into the numbers, just as long as you remember that you’re looking at this data through the smallest of slits anyways.

Nonfarm Payrolls:

Scale the data to 5-years and look at the general direction of the cumulative number, month-to-month percentage change, and year-over-year percentage change.

Building Permits

Construction is a big part of the US economy and it’s also very capital intensive.  How people feel about the future can be expressed in how many of them are willing to go out there and take a risk with capital.  Home prices and construction affects the consumer sectors of the economy in a major way.  I recommend supplementing building permits with the S&P Case-Shiller Home Price Index.

Building Permits:

S&P Case-Shiller Home Price Index:

Look at the overall direction of building permits (use the whole number, forget about altering this data).  Watch both the trend of the of the Case-Shiller Index and the year-over-year.

Consumer Sentiment

The University of Michigan Consumer Sentiment Survey is the second most criticized economic metric (behind Nonfarm Payrolls) by virtue of the fact that it’s a survey.  That’s right, it’s a survey.  This means that whichever member of the household who picks up the phone can bullshit the person on the other end of the line who also happens to be calling them up during dinner and asking them about the economy.  The skeptic in me agrees, but it’s tough to find a sentiment survey with as much history and overall acceptance.  Low readings are thought to mean contraction and deflation.  Bullish readings indicate that people might be getting a little too hopped up and we’re in for some inflation.  I look at this indicator as a long-term contrary indicator on sentiment towards the stock market.  Low readings indicate the wall of worry is in tact.  High readings mean that the public is all in and drinking the kool-aid.  This means that if the market is rallying from a point of depressed sentiment, it probably has a long way to go before it stops.

University of Michigan: Consumer Sentiment:

Monitor for one-standard deviation variances for the wall of worry and the kool-aid-trade.  Readings on the bottom half indicate the rally is mostly safe, top half meaning caution is warranted.  Use the outliers as inflection points.

Leading Indicators

Geoffry H. Moore founded the ECRI and is the grand daddy of forecasting business cycles.  Lakshman Achuthan is carrying his torch. The ECRI is home to the world’s most mysterious and expensive indicators.  Their flagship is the Weekly Leading Index WLIW.  You don’t need to know much about it or how it works except that it has a very good track record.  There have been only a couple notable false positives on recession calls since inception.  One of them occurred very recently and subjected the ECRI to some unwarranted criticism.  One thing that can be said is that the leading indicator data is much more noisy today than in the past.  Previously, anytime growth dipped to the -5% level it was cause for alarm.  Your best bet is to pay attention to when Mr. Achuthan is a guest on Tom Keene’s program.  One warning, he is sometimes early.

Leading Indicators: download the .xls spreadsheet marked WLIW (right side of page).

Download the data and look at the growth percentage column.  -5 readings are consistent with economic slow downs.

Wild Card Indicator

Call this the indicator du jour.  Cost of energy becoming a big deal?  Pull up petroleum inventories and oil prices.  Fed targeting GDP?  Watch GDP.  Fed hawks worried about inflation?  Get glued to the CPI report.  Fed doves looking for a reason to pull the trigger?  Deflating CPI is a good excuse.


Jobs, housing, consumer sentiment, and economic growth expansion/contraction — that’s all that really matters.  Spice it up with some wild cards and you’re good to go.  Look at the overall direction of the indicators and determine whether the economy is healthy or not.  Squint at your reports with the confidence that no matter how smart anyone sounds or how sure they are of themselves no one really knows anything.  That’s the big secret.


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