A mix of top-down & bottom-up approach ideal for investments

If one were to view the stock markets daily, would notice going up and down. By the end of the day, there could be a list of reasons to rationale the movement. At times, news drives the market, it could be unemployment numbers, inflation, etc. These are the macro issues which test the market and its participants' nerves. So, should one concentrate on the macro issues, while investing? But, if one were to look at a particular stock movement, it's driven by not just the macro issues, but also the company earnings, its competition, etc.

How should one base their view or develop the perspective on these issues while investing? It's true that macro factors play an important role in a company's performance. For instance, the larger economic trends, the regulatory and governmental stance would merit beyond just understanding to identify and estimate the stock's growth. But we can't dwell on these aspects in isolation as we've just witnessed the dichotomy at play with regards to the economy and stock markets in the past year or so.

Even as the economy was shrunk and struggling, the stock markets began their ascent. While accepting that the markets are forward looking and so the prospects are better than the current, discounting them in the valuations seemed difficult to digest. The liquidity induced and the capital movement that infused further growth along with the lower interest rate regimes, only accelerated this phenomenon. These are the macro factors that aided the stock valuations.

If one were to make critical observation, though there has been a broader rally, the stock performance is uneven across the stocks and sectors. This is partly due to the very macros, for example, tourism, transportation and hospitality industry suffered the most due to the lockdowns and the imposed restrictions on the movement of people due to the pandemic. These sectors were hit badly and even shrunk the industry overall. Of course, just that the other sectors enjoyed greater visibility, didn't allow a sustained growth in their stocks. The individual stock performance reflected their earnings after a few quarters.

Those companies which took advantage of these macros and adapted their business models have increased their market and profits, thus delivering good returns to the investors. While of those who were less receptive to the changing environment failed to capitalize the situation to their advantage. There were a few which capitulated in this environment despite favourable macros abetting their sectors. This is the factor of the micros or the company level capabilities.

I've interacted with investors who have invested in a sector (across multiple stocks) as they were assessing its prospects, sometimes astutely, but the vagaries of individual companies dragged the averages down. Worse, in a few cases, didn't allow them to exist completely due to liquidity issues. For one to benefit from this investment, it becomes very pertinent that the theme or sector allocated should turn out as planned. So, while investing, one needs to not just rely on the macro factors i.e., top-down approach, but also have an insight on the company profile i.e., bottom-up method.

The ideal way to invest in the stock market would be an amalgamation of these two strategies. In this method, one could marry the best of the two styles and benefit from it. While the top-down identifies the possible sectors or themes that could benefit due to the changes happening or governmental policies, the bottom-up allows one to pinpoint the companies that are prospective to enjoy them. For example, when the governments give push towards decarbonisation, it brings in a different set of stocks to play. The companies that have lesser environmental footprint stand to gain while those who are quick to adopt these policies also benefit. One must be careful to not just identify the right theme or sector but also to check how much of the delta (change in the policy impacting the company's performance) is achieved.

(The author is a co-founder of Wealocity, a wealth management firm and could be reached at knk@wealocity.com)