For retail stock market investing, understanding the macroeconomic environment and the actions of the central banks is not required. Relying on macroeconomic analysis is difficult due to the subject’s complexity.
Macroeconomic analysis is a fascinating area with conflicting opinions. The sample of past recessions and inflation periods is small, and the uncertainty in making forecasts is high. On top of this, regime changes limit the effectiveness of forecasting based on historical analysis. Without high-powered statistical tests, macroeconomic analysts rely on gut feelings and their ability to guess the future state of the economy, the path of inflation, the level of economic output, and the actions of the central banks.
Understanding the macroeconomic environment is useful for long-term asset allocation and rebalancing. However, this takes significant work, requires large volumes of data, and is a dynamic process with a high demand for skills: knowledge of economics, statistics, and markets. This process is beyond the capabilities of the average aspiring macroeconomic forecaster on blogs and social media, who relies on third-party research and publicly available information.
Retail investors have other options than relying on a process that involves randomness and arbitrary decisions. For hundreds of years, momentum has been a documented, robust anomaly in the markets. Simple strategies have performed well over the years. These strategies do not require trying to understand a highly non-linear, dynamic stochastic process like the economy.
The simplest strategy is the 12-month moving average momentum: buy when the price is above the 12-month moving average and sell when it is below the price. This simple strategy has worked well over the years for the S&P 500 total return (SPY). The following is a backtest from January 2, 1994, to August 23, 2024, with 2x leverage.
This simple strategy’s annualized return is more than 16%, with a maximum drawdown of 39.2%. The Sharpe ratio is 0.75. Trading this strategy necessitates checking the price in relation to the 12-month moving average once at the end of each month, rather than spending many hours daily trying to understand the state of the economy. Year-to-date, the strategy is up more than 33%.
More importantly, how many macroeconomic analysts have outperformed this strategy on a risk-adjusted basis?
All strategies have risks, and this simple strategy can suffer in the event that the US stock market enters a multi-year consolidation phase. However, I suspect macroeconomic analysts will lose even more in that extreme environment.
Conclusion: To invest in the markets, retail investors do not need macroeconomic analysis. Momentum solutions range from simple to more advanced. The latter include cross-sectional momentum strategies for asset allocation. These are straightforward methods that have worked well over time. What has been questionable is trying to understand how the economy works.
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Specific disclaimer: This report includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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