1/25 You can’t predict the economy, but understanding the macro context is critically important for bottom up stock pickers. Whether you like it or not your company specific outlook includes a ton of implicit macro assumptions.
The current macro situation demands your attention.
2/25 A lot of company level forecasts are just a form of trend analysis. Most macro trends are usually long duration and slow moving, so you just need a sense of whether macro drivers are above/below mid cycle and how soon/much they might mean revert.
3/25 In a typical cycle, while there are early, mid, and late cycle companies (those that thrive best at various points), all companies are operating within a relatively homogeneous economic context.
4/25 That is NOT what is happening right now. Various parts of the economy are operating at very different points along the typical cycle. And the magnitude of cycle dynamics are unprecedented.
Let’s look at how this is impacting $GOOGL and $HD.
5/25 $GOOGL analysts are not used to accounting for nominal GDP trends when thinking about $GOOGL’s revenue growth. For the decade pre COVID, nominal GDP growth had very low variability. Ad spending is absolutely economic cycle sensitive, but $GOOGL’s secular growth dominated.
6/25 $GOOGL’s ~20% top line growth was 4% nominal GDP +16% secular growth. Whether nominal GDP grew 3% or 5% was immaterial and washed out by higher volatility in the secular growth rate. The macro context was “irrelevant”.
7/25 But nominal GDP has been running at double digital levels! This is highly relevant to an economically sensitive industry like advertising. Street estimates have been consistently too low because analysts aren’t taking into account the macro context.
8/25 The Street’s $GOOGL estimates for the last year or more have generally assumed sequential growth would be similar to what was seen during the much lower nominal growth era pre COVID. But the current macro context boosts *sequential* growth by 2%+. That’s a LOT.
9/25 $HD is more complex, but with a similar backdrop. 1) pre COVID, low macro growth is very different from double digit GDP today, 2) remodel spending as a % of GDP was previously depressed. Now it has surged, but only to “normal”, not elevated levels. eyeonhousing.org/2022/01/housin…
10/25 Within $HD are two customer groups, pro contractors and DIY homeowners that each make up 50% of revenue. Typically they are both at about the same point within the macro trend. But that is NOT the case today.
11/25 DIY home owners splurged during summer 2020 as they were stuck in their house and needed improved outdoor space for socializing during COVID. Today, despite rapid GDP growth, DIY traffic is in decline off monster comps with inflation keeping DIY revenue barely flat.
12/25 Pro contractors on the other hand couldn’t get building permits in 2020 when county offices were barely functioning, and homeowners didn’t want strangers in their house pre-vaccine. So today Pro traffic and spending is *booming* with Pro revenue growing 20%+.
13/25 So even a strictly company level forecast must incorporate the highly unusual macro context. Pre COVID, you could forecast 5% growth & claim you didn’t do macro. But really you were implicitly assuming moderate GDP growth, stable remodel as % of GDP & similar Pro/DIY trends
14/25 Today, none of those assumptions are valid. Knowing what assumptions to use isn’t easy. But falling back on implicit assumptions that are now clearly wrong doesn’t reflect a healthy skepticism of macro forecasting, it reflects a lack of paying attention to the here and now.
15/25 Note how $HD’s guidance for flat revenue was not based on a forward outlook. The company said the outlook was so uncertain they decided to annualized and seasonally adjusted 2H21 revenue and call that their 2022 outlook. $LOW’s *forward outlook* called for flat revenue too.
16/25 $LOW is 25%/75% Pro/DIY, while $HD is 50%/50%. Pro is on fire with massive job backlogs. DIY is in decline as homeowners don’t need to improve their deck again or replace appliances again. Plus they want to travel or at least get out and about this summer, not hide at home.
17/25 So it isn’t plausible that both companies will see the same 2020 growth trends. Yet investors have accepted both sets of guidance as the consensus outlook. The macro context of today demands better. It demands explicit analysis of unprecedented trends.
18/25 Even more challenging, the long term macro trend is highly uncertain. Pre COVID you could assume cross cycle inflation and real growth of 2% each and the uncertain variable was just the timing of recessions (an unforecastable variable).
19/25 This set of post-Financial Crisis, pre-COVID long run macro assumptions was so pervasive that most equity analysts who claimed zero macro expertise still implicitly modeled these assumptions in their company level forecasts, whether they knew it or not.
20/25 But we’ve flipped from a demand constrained to a supply constrained economy. And while we can’t know for sure what comes next, the prior base case of 2% real + 2% inflation is now a low probability edge case. intrinsicinvesting.com/2021/06/11/inv…
21/25 We are business analysts who own a collection of companies. We’re not economists and we certainly don’t think we can predict the path of the economy (neither can economists). But we do think that understanding the nuances of the current macro context is critical.
22/25 Today, a panic about a particular macro outlook (stagflation) has gripped the market. This outlook is heavily impacting secular growth businesses, not just cyclicals. intrinsicinvesting.com/2022/03/09/sta…
23/25 If you ignored macro for the decade pre COVID, your equity investment results may have been unaffected. If you are ignoring it now, you’re introducing a massively large variable into your future investment results without even considering it’s potential range and magnitude.
24/25 But don’t go fooling yourself into thinking you can predict the path of the economy! Your job is just to understand the macro context and the range of reasonable possibilities.
25/x “You do not need to know precisely what is happening, or exactly where it is all going. What you need is to recognize the possibilities and challenges offered by the present moment, and to embrace them with courage, faith and hope.” ― Thomas Merton
Share this Scrolly Tale with your friends.
A Scrolly Tale is a new way to read Twitter threads with a more visually immersive experience.
Discover more beautiful Scrolly Tales like this.