How to Conduct Macroeconomic Analysis

When analyzing macroeconomics, one should not derive future trends from a single event but rather understand at which stage of historical inertia the event is occurring.

Common Misconceptions in Macroeconomic Analysis

Some investors get excited about analyzing the latest news and speculating on various outcomes when faced with sudden macroeconomic events (such as the US-China Trade War at the end of 2018). However, this type of analysis often lacks historical insight.

Short-term Analysis

Some investors tend to categorize economic events as changes in market sentiment, technical analysis, or fundamental analysis and infer that they conform to short-term historical inertia. For example, they are forming double bottom or double top patterns. They use technical analysis to predict the arrival of bearish news, bullish news, or bullish trends.

This analysis model makes it difficult to understand market movements truly. If the trend deviates slightly from short-term historical changes or sentiment changes, investors may not be able to comprehend market dynamics.

For instance, some believe that after the Federal Reserve and the government introduced monetary and fiscal policies, the stock market’s reaction indicated that the policies were starting to take effect, and, therefore, they thought it was time to enter the market.

However, this judgment carries risks. The stock market may rebound after a crash due to news released by the Fed. Investors can easily misinterpret this as an effective policy, but it might be a “dead cat bounce.” It could ultimately lead to being trapped as the stock market falls.

Psychological Expectations

Some investors conduct macroeconomic analysis and trade based on psychological expectations, their perceptions, and comprehensive information.

For example, some believe that quantitative easing (QE) has solved the market’s liquidity shortage problem and that the stock market will rebound; others think that due to lockdowns caused by the pandemic, fundamentals have not improved, and the stock market will continue to fall.

The trading behavior of investors with different views is like voting. If investors who believe the liquidity problem can solved outnumber those worried about fundamentals, the minority will conform to the majority, forming a mainstream market consensus. Investors begin to feel that there are more bullish than bearish sentiments, and the stock market tends to rise. With the multiplier effect, price increases reinforce the mainstream consensus, forming a positive cycle in price trends.

Some investors believe that tax increases will lead to a stock market crash, but historically, the four tax increases in the U.S. stock market occurred during bull markets. It means that tax increases usually happen during periods of economic improvement, and investors need not be overly anxious.

Furthermore, according to historical inertia, USD depreciation typically occurs after the Federal Reserve announces quantitative easing measures.

Conclusion

When investing independently, one should be wary of needing more ability to collect data, think, and analyze. Refrain from reflexively following trends under news stimulation and reaching conclusions you hope for rather than those indicated by facts, as this can lead to severe errors in judgment. For such analyses, it is wise to remain vigilant, think more, and examine whether they conform to historical inertia.