Investors who ignore the macroeconomic backdrop do so at their peril as this has a great influence on how certain sectors will perform at various stages of the business cycle. For instance, in the early stages of a bull market expect higher-risk assets to perform best and small and mid-caps to outperform large caps. Break down the sectors within these groups and financials, media and early cyclical sectors more often than not lead the stock market charge while defensives trail behind.
It is equally important to decide whether the interest rate environment favours allocation of assets in inflationary or interest rate sensitive sectors. This is more crucial now than ever before because the effects of three-and-a-half years of quantitative easing means that markets are moving from periods of 'risk on' to 'risk off' trades characterised by sector rotation from higher-beta stocks and cyclical sectors ('risk on') into defensive and lower betas ('risk off'). This means screening for companies in the right sector at the right point in the cycle has never been more critical for a stock picker. It also explains why for all of this year I have focused on small caps - the one segment of the equity market that benefits most from a 'risk on' trade underpinned by easy monetary policy.
