In a Nutshell: Macro economics addresses the broader health or weakness of an economy at the national or global level. Inflation and deflation are typical macro indicators of economic strength and measure whether prices (not stocks) are rising (inflation) or falling (deflation). Other macro indicators include GDP, sovereign debt levels and consumer strength indicators.
Definition: Macro-economics is the branch of economics which looks at the broader indicators –such as national growth rates, productivity (i.e. GDP, or “Gross Domestic Product”), inflation rates, unemployment rates etc. to determine the strength or weakness of a national or global economy. “Macros” thus look at the bigger picture—the “macro” picture— rather than individual stocks, sectors, indexes etc. Macro themes include the monetary policies (interest rate increases or decreases, money supply increases or decreases) of central banks like the Federal Reserve, the Bank of Japan, the ECB etc as well as fiscal policy concerns, which look at a nation’s spending and taxation policies.
Macro questions essentially boil down to 3 key questions to measure the economic strength of any given country or region, including the global economy, namely:
- How high is its debt to GDP ratio/level? Greater than 100%?
- Is the interest rate policy strong (i.e. higher rates) or weak/accommodative (i.e a very low interest rate policy)?
- What is the condition of the consumer? Is there consumer strength (high buying power) or consumer weakness (low buying power)? Are employment rates high or low? Full time or part time?
Inflation: A key component of any macro discussion is the concern over managing inflation. Inflation is defined as a general increase in prices as measured by an index (or “price scale”) known as the CPI, or Consumer Price Index. Prices and thus inflation can go up in good times if there is excessive demand for goods in which the demand outpaces the supply of those goods. Inflation can also occur when a central bank increases the money supply, and that increase in money supply far surpasses the growth rate, or GDP, of that nation. Dramatically low interest rates can also lead to monetary expansion and inflation.
Do not confuse rising stock prices with rising inflation/CPI prices. A rising stock market is not “inflation,” just as a declining stock market is not “deflation.”
Deflation. Deflation is a general decline in prices as measured by the CPI and is typical in recessions where the supply of goods far outpaces their demand. Similarly, if there is severe shrinkage of the money supply or a dramatic interest rate hike, deflation can increase as well.
Risks: Today macro-economic conditions (in the US, Europe, Asia and elsewhere) are at record high levels of risk and weakness when measured by each of three indicators above. Market performance, however, doesn’t typically mirror macro weaknesses—at least not immediately. In fact, macro conditions can be extremely poor for many years before the markets reflect the underlying weaknesses in an economy. Since the 2008 market crisis, for example, intervention by the central banks in propping up the stock and bond markets through policies of bond-buying (called “quantitative easing” or “QE”) and low interest rate setting, has been a great boon for the stock market yet hardly have any impact on the actual “Main Street” economy, whose GDP has stagnated while the stock and bond-markets, supported by the overly aggressive and historically unprecedented monetary policies (QE and extended low rate periods) of the world’s central banks, have reached record highs. This “disconnect” between markets and macros will not last forever. At some point the markets will plunge and reflect the weak macro realities. In short, macro risk is a very important (if not the most important) consideration in today’s current investment environment and discussion.
Further Reading: There are numerous macro papers which address this critical issue of macro risk in the post-08 world. For a basic understanding of macro indicators, see “Simple Macro Indicators;” otherwise “U.S. Market History,” “Titanic Markets,” “The Rain Ahead,” and “U.S. & Global Markets 2015” offer easy to read, broad explanations of current market risks created by macro conditions.