Introduction

The Federal Reserve hikes interest rates, consumer confidence falls, war breaks out in the Balkans, drought shrinks the coffee crop in Brazil, oil prices spike sharply in Rotterdam, Congress passes new Medicare legislation imposing price controls on prescription drugs, and the U.S. trade deficit reaches a new record high. Each of these macroeconomic waves—some of them thousands of miles away—will move the U.S. stock market in very different but nonetheless systematic and predictable ways. If you come to fully understand these macrowaves, you will become a better investor or trader—no matter what your style of investing or trading is. That’s the power of macrowave investing, and that’s what this book is about. Let me show you what I mean with just a few examples of some fictional microinvestors in very real situations.

 

• Jim Fleet is a day trader and a very good one. Typically, he follows a momentum strategy to “scalp teenies.” That is, he buys or shorts large volumes of a stock based on a stock’s up or down momentum. He never holds the stock for more than a few minutes, and he makes his money when the stock goes up or down by a “teenie”— of a point—or more. With working capital of $50,000, Jim usually rakes in about $2,500 a week. Yesterday, however, he lost $20,000 on a Wal-Mart stock play after a computer glitch cut off his access to the market for a few minutes. During that time, the Conference Board released data showing a very sharp and unexpected drop in consumer confidence. Minutes after CNBC reported this news, stocks in the entire retail sector swooned. By the time Jim got back online, Wal-Mart was way down and Jim was out a month’s profits.

• Jane Ellington is a swing trader who typically buys or shorts a stock over a one-to-five-day period. Her strategy is to use technical analysis to identify higher-volume and moderately volatile stocks that are trading comfortably in a range. Then, she “buys on the dip” and “sells on the peak.” Over the last year, Jane has used this strategy to make about $500 a week, which is a very nice supplement to her regular salary as a marketing executive. However, last week, she lost $8,000 on one trade after the government released the monthly Consumer Price Index data. These data showed the core rate of inflation spiking sharply upward. The entire market promptly tanked, and Jane—oblivious to the news—got caught in the downdraft.

• Ed Burke is an ex–Navy petty officer and a retired petroleum engineer. He’s a pretty conservative buy-and-hold investor who likes to hold a large portion of his portfolio in blue-chip oil stocks like Chevron and Exxon. Last May, in the space of just three weeks, he made $40,000 in paper profits when the price of a barrel of oil rose steadily from $26 to $39, and Jim’s oil stocks moved up sharply. However, after the OPEC cartel met in June and relaxed its production quotas, oil prices began to fall back down. By July, when oil prices had sagged to $20 per barrel and dragged oil stocks down with them, Ed’s $40,000 paper profit had turned into a $10,000 paper loss—a swing in the value of his portfolio of some $50,000.

Now obviously, these three investors are as different as night and day in both their trading strategies and investing styles. However, they all share one thing in common. They all lost money because they chose to ignore the powerful impact that macrowave forces can have on the stock market.

Sure, it was bad luck that Jim had computer problems. However, Jim also knew, just like any good day trader knows, that computers can crash at any time. Knowing this, Jim could have easily avoided trading a retail sector stock on a day when data on a major economic indicator like consumer confidence were to be released—if only he had been thinking like a macrowave investor.

As for Jane, the worst thing a technical trader can do is to ignore broader macroeconomic signals like a possible inflationary spike or sharp rise in the unemployment rate. This is because it is precisely such macroeconomic shocks that can throw all stocks abruptly out of their trading ranges and, at least temporarily, render technical analysis meaningless.

Of course, Ed may have been doing the right thing—at least for Ed. That’s because, by temperament, he is a long-term investor who likes to buy and hold blue-chip stocks with strong fundamentals and not worry about fluctuations in paper profits. On the other hand, if an investor like Ed is going to have a portfolio that is so heavily weighted in a particular sector like oil, rather than be diversified, it borders on foolishness to ignore macrowaves that can strongly influence that sector. Indeed, in this case, if Ed had simply been paying attention to price movements in the world oil market, he’d be $40,000 richer rather than $10,000 poorer.

The broader point of these examples—and the ultimate point of this book—is that regardless of what kind of trader or investor you are, a deeper appreciation of the systematic effects of macroeconomic events on the stock market can help you in your trading and investing decisions. Moreover, such a macrowave perspective can help you in two very specific and very profitable ways.

First, by adopting a macrowave perspective, you will be much better able to predict and anticipate broad trends in the market. Will the stock market be up or down today? Or next week? Or even next year? This is powerful information to arm yourself with because you never, ever want to trade or invest against the trend. That was Jane Ellington’s mistake, and it cost her dearly.

The second way that a macrowave perspective can help you is equally powerful. As we shall soon see, even in an up-trending bull market, some sectors like computers or electronics may rise much faster than others like chemicals or autos. Moreover, in a bear market, some sectors like housing and technology may fall much farther and faster than other so-called “defensive sectors” like food and pharmaceuticals that can provide you with much safer investing havens.

The good news here is that a macrowave perspective will help you identify the key sectors to trade in—or stay away from!—given particular kinds of macroeconomic news. In this sense, a macrowave perspective serves as a powerful trading compass, and it is just such a compass that both Jim Fleet and Ed Burke in our examples above could have used to a very profitable advantage. Here’s the roadmap we will be following:

Part One lays down the analytical foundations of macrowave investing. This begins in Chap. 1, where we will systematically work our way through the various kinds of macrowave forces that can bear down, buffet, or buoy the various U.S. and global financial markets. These macrowaves range from inflation, unemployment, and slower economic growth to earthquakes, wars, and international currency crises.

In Chap. 2, we turn to what should be both an entertaining and very useful history of the warring schools of macroeconomics. These schools range from Keynesianism, monetarism, and supply-side economics to the latest school of new classical thinking, which is based on the controversial idea of rational expectations. This chapter is important because so many of the decisions on macroeconomic policy that are made in Congress and the White House and at the Federal Reserve are driven by which particular school of economics happens to be in vogue at any particular time.

Chapters 3 and 4 then tackle the crucial task of examining the major tools of macroeconomic policy, principally fiscal and monetary policy. In these chapters, which complete Part One, we will come to understand not only how these policies work but also what their often far-ranging effects can be on global financial markets. For example, when Chairman Alan Greenspan sneezes at the Federal Reserve, Europe very often catches a cold—along with the stocks of U.S. companies that export heavily to Europe. We need to understand why. Similarly, when the OPEC oil cartel raises prices or the Japanese economy goes into a tailspin, the U.S. economy is likely to falter and pull the stock market down with it. Again, we need to understand why.

In Part Two, we get down to the nuts and bolts of macrowave investing. This begins with Chap. 5, which examines the major principles of macrowave investing. Here, we illustrate how a firm grasp of these principles generates profit opportunities. Then, in Chaps. 6 and 7, we examine the stock market from the macrowave investor’s perspective. In these key chapters, we will see that when the macrowave investor looks at the stock market, he or she not only sees companies like Chevron, Compaq, or Wal-Mart. He or she also sees market sectors like energy, computers, and retailing. This is because many of the biggest moves in the stock market are sector-driven rather than company-driven. Quite literally capitalizing on the systematic differences between the various market sectors is at the core of the macrowave investing approach.

In Chaps. 8 and 9, we move on to the crucial topics of protecting your trading capital and managing your investment risks. Then, in Chap. 10, we reaffirm one of the major themes of this book, namely, that any kind of trader or investor can benefit from the power of macrowave investing. This chapter does so by illustrating how macrowave investing can be applied to different styles and strategies of trading and investing.

To complete Part Two, Chap. 11 presents the macrowave investor’s checklist. Here, we see that just as a good pilot methodically goes through an extensive checklist before every flight, so too does the macrowave investor go through a checklist before every trade.

In the third and final part of this book, we turn to the all-important task of illustrating macrowave investing in action. Each of the chapters in Part Three focuses on a specific macroeconomic force such as inflation or recession or productivity. Importantly, the architecture of each of these chapters is the same.

We first learn about which economic indicators like the Consumer Price Index and the Jobs Report are the most important to follow and when the data for these indicators are regularly released. Then, we move to the crucial task of examining how each particular macroeconomic force might affect different sectors of the stock market. This analysis is the heart and soul of this book; it is from this analysis that you, the savvy macrowave investor, are most likely to profit.

For example, when we look at inflation in Chap. 15, we will see that interest-rate sensitive sectors like banking, brokerage, and retail typically react the strongest to inflation news, while defensive sectors like utilities, energy, and consumer staples react the weakest. Using this kind of information, you can buy into the strongest-reacting sectors on good inflation news or short-sell on bad news—or simply flee to the defensive sectors for shelter.

It is important to note that each of the chapters in Part Three is modular. That is, each stands alone and, in fact, the chapters can be read in any order. Because of this, you should find this book to be a very useful reference volume for your financial market shelf once you’ve read it. This is because you’ll be able to consult the book every time you want to refresh your memory as to how the markets are likely to react to the latest piece of impending macroeconomic news.

With this, then, as our roadmap, let me provide you with one cautionary note. Because Part One of this book lays down our macroeconomic foundation, it may, at times, be a very challenging section to read. But take heart. Once you get to Parts Two and Three, it will be all smooth sailing. And all that hard work you did getting through the important conceptual material in Part One will pay off for you many, many times over. That’s my promise to you, and it’s a promise based on my years of experience developing the ideas in this book. So with that said, let’s get started with the power of macrowave investing!