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Royce Funds Commentary - The Great Divide: Company Fundamentals vs. Macroeconomics

May 17, 2012 | About:

Holly LaFon

254 followers
A recent headline in USA Today caught our attention – "Invest in Stocks? Forget About It." The article included the following claim: "Wall Street's long-running story about how stocks are the best way to build wealth seems tired, dated and less believable to many individual investors."

The piece reminded those of us in our office old enough to remember of another provocative headline—the famous BusinessWeek cover story from August, 1979, which confidently trumpeted "The Death of Equities." Needless to say, our contrarian instincts are always piqued when we see popular trends so at odds with what we are seeing in our day to day work.

At Royce, we pride ourselves on our singular focus on company fundamentals. That said, we also recognize that many inputs go into any attempt to determine the potential success or failure of a given investment, as well as the expected time period over which that outcome may be realized. Companies are complex and must always try to balance the internal factors over which they can exert control and external factors over which they often have very little control.

The latter consists of a range of macroeconomic factors that can impact their business, such as the pace of economic activity, interest rates, regulation, and politics. As potential investors, we also need to carefully weigh internal and external factors in order to draw a rational conclusion about the potential risks and opportunities for our capital. We take this especially seriously because, as long-term investors, we always view ourselves as becoming part owners in a business.

We devote most of our time engaged in bottom-up analysis. We have found it far more productive to concentrate our research efforts on individual companies than to try to predict the future direction of macroeconomic trends. Our nearly forty years of experience has taught us that, over time, companies tend to have more influence on their own success or failure than do the broader economic trends around them.

That's not to say that economic events don't matter—they certainly do—but they tend to matter more in the context of how they make investors behave in the short run than whether or not a company is a good investment over the long run.

The current environment is particularly interesting in that global headlines are the only thing that seem to matter to investors. This is not surprising considering the array of remarkable, seismic events that have occurred across the globe over the past several years.

But it is clear that a disproportionate amount of investor attention is now claimed by information far removed from the specifics of a company's particular business. The macro is now overwhelming the micro, and in that divide we see opportunity.

We have been arguing that the related development of increasingly short average holding periods for investors means that these periods are increasingly disconnected from what a company may be demonstrating in its results.

In addition, the current environment has been particularly volatile and fraught with uncertainty. Companies are slower moving entities than the headlines around them that now drive investor decisions to buy or sell stocks.

Is this rational? Perhaps to some. Stock markets, after all, are ultimately reflections of the collective wisdom of their participants. Currently, that collective wisdom is challenging the long-held belief that investing in equities is an effective way to build wealth over the long run.

So the current great divide yawns between those such as ourselves, who believe that the weight belongs on fundamentals, which we see as best determining a company's success or failure, and those who place the emphasis on the macroeconomic environment in which companies operate, which we see as consisting largely of variables that are difficult to assess.

We take some measure of comfort from an idea that has endured over time, which is the benefit of looking critically at what the consensus is doing and selectively doing the opposite. This has always been our practice; it is even more critical to be contrarian now that so many are questioning the value of investing in equities at all.

Important Disclosure Information

Chris Clark is a Portfolio Manager and Principal of Royce & Associates LLC. Mr. Clark's thoughts in this essay concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements.

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