Stop obsessing about the RBA

Overview

It’s infrequently stated openly, but analysts, journalists and investors apparently accept it as conventional wisdom: the consequences of changes to central banks’ policy rates of interest are consistent and significant. After the Reserve Bank of Australia cuts its Overnight Cash Rate, for example, they believe that this country’s stock market indexes generally lift; and when the RBA lifts the OCR, these indexes typically sag.

Market participant and observers also seem tacitly to agree that the anticipation of a rate cut(s) tends to boost stocks’ returns, and the expectation of a rise(s) tamps them – and even triggers losses. For both sets of reasons, analysts, journalists and speculators almost invariably favour lower rates and ceaselessly urge central banks to reduce them.

These beliefs are widely and strongly held – but are they soundly based? I demonstrate that in Australia, at least, they grossly distort the truth.

Specifically, since 1990 the OCR’s levels and changes have at best feebly impacted Australian stocks’ short-term returns. Indeed, returns have been highest when – regardless of its level – the RBA leaves the OCR unchanged. Australian stocks’ short-term returns can also weakly influence the RBA: the higher is the market’s loss during a given period, the greater is the central bank’s tendency to decrease of the OCR during the next.

The RBA’s effect upon stocks isn’t direct or powerful. Nor, in all likelihood, is it consistent; accordingly, since 1990 it’s basically been random – and thus unpredictable (see also How experts’ “systematic mispredictions” improve our returns, 6 August 2024).

Hence my key conclusions: firstly, other factors, almost certainly including investors’ and speculators’ erratic cycles of fear and greed, the (in)actions of the U.S. Federal Reserve – and, probably most importantly, an ever-changing conga line of transitory issues – usually exert a much more significant impact upon Australian stocks than the RBA does. Secondly, you should ignore what’s typically insignificant and almost never predictable – such as the RBA’s influence upon Aussie stocks’ returns.

Today’s Confident Two-Part Consensus

During the past few weeks the speculation has become intense. Ever more people – economists, prominent investors and speculators – now agree: at its next meeting on 17-18 February, the RBA will finally (and for the first time since November 2020) reduce its policy rate (see, however, ‘Very weak’: Warren Hogan dismisses RBA rate cut case, 7 February). The OCR, says the RBA, is “the interest rate that banks pay to borrow funds from other banks in the money market overnight. It influences all other interest rates, including mortgage and deposit rates.” 

That’s one reason why the RBA’s policy meetings have for long been so important to so many people: in a debt-soaked economy like Australia’s, higher rates intensify the stress upon debtors (such as governments and people with large home loans) and lower rates abate it. Politically, debtors are very important and savers don’t count. Hence lower deposit rates, reduced interest income and weakened incentives to save don’t concern politicians (including central bankers), but higher rates and mortgage stress certainly do.

There’s another reason why so many people presently demand lower rates. The Australian (“Falling rates to send stocks ‘meaningfully higher,’” 30 January) states it openly: “falling interest rates will help boost the sharemarket this year.”

“Speaking at the launch of her new long-short hedge fund,” a prominent funds manager confidently predicted that “the Australian market would be ‘meaningfully higher’ by the end of the year on the back of lower interest rates, improving business and consumer confidence, cyclical improvements and record levels of liquidity.”

Specifically, “she (is) expecting the Reserve Bank to cut interest rates (by which she presumably means the OCR) at its February meeting on the back of easing worries about the outlook for inflation. She said (the OCR) would be down by 75-100 basis points by the end of the year.”

Astute managers of long-short hedge funds are stoic; they’re neither upbeat nor downcast. This one, however, is unreservedly buoyant: “we started 2024 bullish and maintained our view throughout the year. As we head into 2025, we see no reason to adjust this view and are happy to be on the bullish side of a more moderate (which I assume means less downcast) consensus ... In Australia, the RBA has not even started to reduce policy rates, and this tailwind can be expected to gather momentum early into 2025.”

She acknowledged that equities’ expected gains likely won’t come without occasional and temporary reverses: “she said it was normal for sharemarkets to have two 5% corrections each year and a 10% correction every 18 months.” Her business partner summarised their outlook: “off the back of enormous leverage of excess liquidity in the system, and easier financial conditions (which presumably means, among other things, lower rates of interest), we think equities will have another strong year ...”

They’re hardly the only ones who’re confident that during 2025 the RBA will repeatedly reduce the OCR – and that these actions will boost stocks. “More banks and economists,” a prominent broker told The Australian (“ASX hits record as rate cuts loom,” 31 January), “are coming out and saying that the RBA will definitely cut at their February 18 meeting. So there is no way they won’t. If they don’t then the market would be smashed on February 18. Too much money has poured into the market on (the basis of these) expectations and (the announcement of a cut) is now a lay down misere.”

Robert Gottliebsen (“Rate cut won’t end pain,” The Australian, 3 February 2025) goes further: “the RBA’s (Governor) Michelle Bullock and (Deputy Governor) Andrew Hauser are being ambushed in an unprecedented drive to lower interest rates ... It is rare for the (RBA) to make a decision that goes against such a united front so there is a high likelihood of lower rates.”

As a brief aside, this broker’s and Gottliebsen’s claims are refreshingly contrarian - and even iconoclastic.

They’re strongly implying – I don’t disagree – that the RBA’s much-vaunted “independence” is a genteel sham. It’s independent of Parliament and Treasury, but at certain times it’s the obedient servant of equity markets. Loud voices are presently demanding that it slash the OCR – and if it doesn’t they’ll throw a tantrum!

Others share this broker’s and Gottliebsen’s expectation. Summarising Big Four bank economists’ views, The Australian (31 January) concluded: “February is the most likely start for a gradual easing in interest rates ... All of the four major banks are now predicting a rate cut on (18 February) ... NAB sees the cash rate hitting 3.1% by February 2026 from 4.35% now.” 

That’s the equivalent of 125 basis points, e.g., five cuts of 25 basis points per cut.

Shane Oliver affirms this two-part consensus. First, during 2025 the RBA is likely to reduce the OCR several times; second, these cumulative cuts will boost Australian stocks. According to The Australian (“ASX hits high as rate cuts loom,” 31 January), hereckons that “the (stock) market (is) likely to benefit from three to four rate (presumably of 25 basis points each) cuts throughout the year.”

These cuts, Oliver elaborated, “will likely be spread out. But it’s a bit like when you see a cockroach – there’s usually a few others around.”

Previous Research

“There is ample evidence,” conclude Ricardo Caballero and Alp Simsek in a scholarly article (“Central Banks, Stock Markets, and the Real Economy”) published in 2024, “that monetary policy (in the U.S.) affects asset prices and, in particular, stock prices.”Almost 50 years ago, one of the first analyses in this field concluded that a “surprise” decrease of the current and future rate of money supply growth negatively impacts stocks’ returns. 

Around the turn of the century, a spate of research found that an unanticipated 25 basis point increase of the Federal Funds Rate (FFR, the American equivalent of the OCR) generates a decline of as much as 1.7% in the S&P 500 Index. Other investigators, including Ben Bernanke, subsequently the Federal Reserve’s chairman, corroborated this result. In 2022, two economists, Michael Bauer and Eric Swanson, synthesised and extended this literature. They concluded that a surprise increase of the FFR of 100 basis points leads, on average, to a drop of the S&P 500 of 5.4%.

What about all changes - not just surprises - of the FFR? What about the RBA’s impact upon Australian equity indexes? I’ve located plenty of unsubstantiated assertions but no convincing research.

There’s also evidence from the U.S. that the arrow of causality points in the opposite direction, i.e., that the Fed monitors financial markets closely and reacts to large movements of stock prices. One study finds that a 5% rise of the S&P 500 Index increases the likelihood by one-half that the Fed will lift its policy rate 25 basis points; another finds that each increase of 1% of the CPI-adjusted S&P 500 triggers an increase of ca. 4 basis points of the FFR.

The most recent research sheds further light on the American central bank’s reaction to the stock market’s short-term fluctuations:

1. One study measures the sentiments expressed by members of the Federal Open Market Committee. It concludes that the impact of the stock market on this sentiment is similar in magnitude to the one for inflation – and much larger than those for unemployment and GDP growth.
2. Another uncovers evidence of the “Fed put” (that is, the tendency of the Fed to provide “monetary policy accommodation” – a lower funds rate – in response to negative stock market returns). Specifically, a 10% decline of the S&P 500 reduces the target FFR by 32 basis points at the next meeting and by 127 basis points after one year.

My Analysis and Its Results

A Summary of the RBA’s Policy

Using data compiled by the RBA (file A2), Figure 1 plots the OCR since January 1990. Its overall trajectory is strongly downward: it fell from 17.25% at the end of that month (during the month the RBA cut it by 75 basis points) to 0.1% from December 2020 to April 2022; from then until now (17 February 2025) it’s been 4.35%. Over much shorter intervals within this ca. 35-year period, both downward and upward movements have occasionally been sharp. From January 1990 to July 1993, for example, it plunged to just 4.75%. That was a decrease of (4.75- 18.0) ÷ 18.0 = 74%.

Figure 1: RBA’s OCR, Monthly, January 1990-December 2024

In August 1994, the RBA commenced what became a short and sharp campaign to lift the OCR. By December of that year it reached 7.5% – a total rise of 76% and an annualised rate of increase of 76% ÷ (5/12) = 182%. The RBA’s most extended series of increases began in May 2002. In that month it lifted the OCR 25 basis points to 4.5%. It continued to increase until the OCR reached 7.25% in March 2008. That was a cumulative increase of 300 basis points and 81%.

During the GFC, on the other hand, the RBA slashed the OCR. It commenced its cuts in September 2008 (by 25 basis points to 7.0%) and concluded them in April 2009 (by 25 basis points to 3.0%). That was a cumulative fall of 425 basis points and 59%. By May 2010, however, in a rapid series of increments it lifted the OCR by one-half to 4.25%.

In November 2011, Australia’s central bank began its most extended and dramatic series of rate cuts: by November 2020, when it cut the OCR by a final 15 basis points, it reached an astounding 0.1%. That was a cumulative decrease of 465 basis points and a collapse of (0.10- 4.75) ÷ 4.75 = 98%. But one extreme begets another: in May 2022 the RBA commenced its sharpest (in percentage terms, albeit from by far the lowest base) increase in its history. By November 2023, the OCS reached 4.35%. That was an increase of 425 basis points, 42.5-fold and 4,250%!

What’s a “normal” OCR? Figure 1 suggests two candidates. The first is its mean since January 1990 (4.6%); the second is the current (December 2024) value of its trend since 1990 (2.5%). Today’s confident consensus, in effect, rejects the first and favours the second: it’s demanding that the RBA lower its OCR away from its average since 1990 and towards its trend since 1990.

This raises a crucial question: is today’s confident consensus assuming that the OCR’s strongly downward trend since 1990 remains securely in place? Is it supposing that the allegedly “emergency” rates imposed during the GFC have – or should – become permanent?

Is the consensus demanding, in effect, that the RBA suppress the OCR to a level which overextended debtors can afford? Is it suggesting that investors have a right to the “stimulus” of artificially low rates and the capital gains that they apparently generate?

The OCR’s Level

Answers to the foregoing questions presuppose an affirmative response to questions such as: does the OCR’s level during a given month help to predict the All Ordinaries Index’s total real return during the next 12 months? Specifically, do lower OCRs at a given point in time tend to generate higher returns over the next year? Do higher OCRs generally produce lower subsequent returns? At the end of January 1990, the OCS was 17.25%; in response to the recession of the early-1990s, during the next 12 months the All Ords’ total CPI-adjusted return was -27.0%. Figure 2 plots these pairs of observations for each month to December 2023.

Figure 2: RBA’s OCR and All Ords’ CPI-Adjusted Total Return, Next 12 Months, January 1990-December 2023

The OCR’s level at the end of a given month doesn’t significantly influence the Index’s return during the next 12 months. For all practical purposes, these variables’ correlation is zero.

Figure 2 plots the relationship between the OCR’s level and the All Ords’ return across the OCR’s entire range since 1990. What about the relationship, if any, at levels that today’s confident consensus reckons will prevail at the end of the year? Recall that it expects that during 2025 the RBA will cut the OCR between 75 and 125 basis points, i.e., to 3.1-3.6%. Figure 3 plots equities’ average returns since 1990 at OCRs between 3.0% and 4.35%.

Figure 3: All Ords’ Average, CPI-adjusted Total Return at Given OCRs, January 1990-December 2023

At first glance these results will please today’s confident consensus. They’re uniformly positive; moreover, equities’ average returns at these target OCRs exceed the average return at the current (4.35%) OCR. The lower is the policy rate over this range, in other words, the higher on average are stocks’ returns over the next 12 months.

On the other hand, and as the size of the standard deviations relative to the means implies, the returns at each OCR vary greatly. Within the range 3.0%-3.1%, for example, they vary from -4.9% to 28.5% and their standard deviation is 10.6% – versus a mean of 7.2%. Further, we must extrapolate very cautiously from a small number of observations: at the end of only five 12-month periods (three of which were during the GFC), for example, has the OCR fallen within the range 3.25%-3.35%; during only seven 12-month intervals has it fallen within the range 3.5%-3.6%, etc.

The OCR’s Changes

At the end of a month, investors know (or, with little effort, can easily inform themselves) the changes, if any, of the RBA’s policy – that is, the net increase or decrease of the OCR, expressed in basis points – during the previous 12 months. They also know the total “real” (CPI-adjusted) return of the All Ordinaries Index over that interval. Looking backwards, in other words, the acuity of their vision regarding monetary policy and the stock market’s return is 20/20.

But the future is at best murky and usually the fog is impenetrable. By how many basis points will the RBA change the OCR over the next year? What will be its level in a year’s time? How will this change of the OCR, if any, affect stocks’ returns? A confident consensus is hardly the same as perfect foresight: the honest answer to each of these three questions is thus “we simply don’t know.”

But we do know how the future unfolded in the past. The key question is thus: to what extent does the past give us some idea about the future? With the benefit of hindsight, have cumulative changes of the OCR during the next 12 months helped to predict the total real returns of the All Ordinaries Index over that interval?

For each month from January 1990 to December 2023, I calculated the cumulative changes (in basis points) of the OCR over the next 12 months, and to each month’s observation I paired the All Ord’s total real return over that same interval. Figure 4 plots these pairs of observations.

Do decreases of the OCR presage higher returns? Do increases of the OCR lead to lower returns? The short answers to these two questions, Figure 4 tells us, is “no and yes.” (Results using coterminous data, that is, changes of OCR and returns during the same period, are much the same. For the sake of brevity I’ve therefore omitted them.)

Figure 4: Changes of OCR (bp) and the All Ords’ CPI-Adjusted Total Return, Next 12 Months, January 1990-December 2023

The relationship is curvilinear. The more the RBA lifts the OCR during a given 12-month period – the greater, in other words, the number of basis points by which it raises its policy rate – the lower is stocks’ return during the subsequent period. Equally, however, the more the RBA slashes the OCR the lower is the trend return. (It seems that the RBA is most likely to slash the OCR when economic growth is sharply decelerating or reversing, or because it and investors foresee a strong likelihood of a slowdown or recession. Both circumstances tend to cause stocks to swoon.)

Stocks’ highest returns occur when the OCR remains unchanged. Perhaps this result reflects the adage that investors crave stability and dislike risk and uncertainty.

The relationship in Figure 4 is much stronger than the one in Figure 2, but it’s nonetheless weak. Changes of the OCR explain just 9% of the variation of the All Ords’ total real return; hence other factors explain the overwhelming majority (91%) of the variation. At most of the changes of OCR, a very wide range of total real returns occurs.

When the RBA cuts 25 basis points, for example, the All Ords’ total real return averages 3.2%. But the variation around this mean is enormous: the maximum return is 16.8% and the minimum is -14.4%, and so on for cuts of 50 basis points, 75 basis points, etc.

What do the results in Figure 4 tell today’s confident consensus? To answer this question, recall the cuts to the OCR (between 75 and 125 basis points) which the consensus expects during 2025.

If past is prologue – that is, since 1990 – then the vociferous consensus should carefully consider what it demands.

The more the RBA cuts the OCR over a range -25 to -125 basis points during a forward 12-month period, the lower, on average, is the All Ords’ return during that period (Figure 5). During the intervals when the RBA has cut by 125 basis points, the average total real return has been just 0.1%.

Figure 5: All Ords’ Average, Prospective, CPI-adjusted Total Return at Specified Changes of OCR, January 1990-December 2023

Why is a cut of 100 basis points associated with such a strong return? One-third of these 22 observations occurred in the immediate aftermaths of recessions. During these periods, stocks’ returns zoomed: they always exceeded 20% and sometimes approached 45%.

As in Figure 4, so too in Figure 5: the returns for each change of OCR vary greatly. In all but one category, the standard deviation exceeds its mean. The relationship, in brief, is at best very weak.

Do Stocks’ Returns Influence the RBA?

Does the All Ords’ total real return during a given 12-month period affect the RBA’s policy during that period? As stocks rise sharply, does the RBA tend to lift the OCR? Figure 6 shows that it doesn’t. As stocks plunge, does the central bank slash the policy rate? Figure 6 also shows that it tends slightly in this direction. Overall, however, the relationship is very weak (and cuts of 100 basis points and more contain few cases).

Figure 6: All Ords’ CPI-Adjusted Total Return and Coterminous Changes of OCR (bp), January 1991-December 2024

Do stocks anticipate the RBA’s moves? In other words, does the Index’s total real return during a given 12-month period affect the RBA’s policy during the next 12-month period? For example, do stocks rise sharply in anticipation that the RBA will cut the OCR? Figure 7 shows clearly that they don’t: a rise in stocks during one period is associated with an increase of the OCR during the next. Do stocks’ returns fall or even plunge in anticipation that the central bank will hike its policy rate? Figure 7 also shows that they don’t. On the contrary, a decrease of stocks’ returns during one period is associated with a decrease of the OCR during the next period.

Figure 7: All Ords’ CPI-Adjusted Total Return and Subsequent Changes of OCR (bp), January 1990-December 2023

In summary, the All Ords’ total real return during a given 12-month period slightly affects the RBA’s policy during the same period (Figure 6) – and its return during the next period is barely stronger, i.e., still weak (Figure 7).

Conclusions – and Conundrums

From my analysis I draw six conclusions:

1. The OCR’s level at the end of a given month doesn’t influence the Index’s return during the next 12 months.
2. The lower is the OCR’s level over the range that today’s confident consensus expects by the end of this year (3.1% to 4.35%), the higher, since 1990, have been stocks’ average prospective returns. This result will please the consensus.
3. Do higher returns tend to accompany significant (75 to 125 basis points, as the consensus expects) decreases of the OCR? Quite the contrary: the more the RBA slashes the OCR the lower is the All Ordinaries Index’s trend return. This result should concern the consensus.
4. Stocks’ highest returns over the course of a year occur when the OCR remains unchanged during that 12-month period. Perhaps this reflects the adage that investors crave stability and dislike risk and uncertainty. This result, too, will displease the consensus.
5. Do stocks’ returns influence the RBA? If stocks plunge, does the central bank tend to reduce or even slash the policy rate? The RBA generally cuts in response to economic weakness, which stocks’ losses anticipate or accompany; it typically doesn’t – as the consensus expects – cut in the absence of such conditions.

My sixth and most important conclusion is that results 1-5 are very weak. The impact of the RBA’s policies upon stocks’ returns since 1990 has at best been slight.

For that very reason, today’s confident consensus could be correct: during the coming year the RBA might lift the OCR up to 125 points, and these increases could boost stocks. But if so, these correct “predictions” would result from mere chance – and not from any innate ability to predict reliably. Moreover, the odds don’t favour the consensus: although in 18% of the 12-month periods since January 1991 the RBA has cut the OCR by at least 125 basis points, except for the COVID-19 panic it’s not done so in more than a decade.  

My results will likely disappoint and perhaps even startle most analysts, investors, journalists and speculators. Their obsessive speculation about the RBA’s upcoming decisions is a colossal waste of time. For two reasons, these results don’t surprise me.

Reason #1: the RBA Isn’t Really Independent

The RBA’s day to day operations, its backers insist, are independent of Parliament and Treasury – and never mind that the Treasurer appoints its Governor and board (on this key point, see in particular Judith Sloan, “Beginning of the end of an independent Reserve Bank,” The Australian, 10 December 2024). Yet sometimes (we’ll see on 18 February!), it apparently must defer to the strident demands of Australian markets.

These statements aren’t completely false, but they omit the crucial point: the RBA cannot indefinitely act independently of the Federal Reserve and the world’s other major central banks. One reason why the RBA’s changes of the OCR don’t significantly affect Australian stocks’ returns is because Australian investors are mostly looking elsewhere.

The long-term trend in Figure 1 superficially records the RBA’s policy since 1990. More profoundly, however, the RBA’s actions reflect the policies of the world’s most powerful central banks. Australia is a relatively small and largely open economy; it therefore cannot ignore and defy economic conditions and developments from its major trading partners and the world’s major economies. The same point applies to Canada, New Zealand, etc. – and to the Bank of Canada and RBNZ, etc.

Figure 8, which plots the OCR and FFR, illustrates this key point. The two series are reasonably strongly correlated (r² = 0.533). From 1990 until 2018, the OCR almost invariably exceeded the FFR; since then, however, they’ve mostly been equal (the FFR’s current target is 4.25-4.5%; the OCR’s is 4.35%).

Figure 8: Australian and U.S. Central Bank Policy Rates, Monthly, January 1990-December 2024

The two central banks’ policy rates since 2018 raise interesting questions. Does the confident consensus assume that the OCR can fall even lower relative to the FFR? Does it suppose, in other words, that henceforth the RBA can act independently of the Fed? The RBA’s cut of 75-125 basis points, if it occurs and the Fed stands pat (which, in the wake of the unexpectedly “hot” CPI numbers released on 12 February, future markets say is increasingly likely), will increase the FFR’s disparity over the OCR to an unprecedented degree.

How long can that last? If Jay Powell, the Fed’s chairman, is in “no hurry to cut,” then can Michelle Bullock be?

Reason #2: Contradictory Relationships

I suspect that the RBA’s impact upon Australian stocks’ returns is slight primarily because, considered as a group, the consensus’ major hypotheses work at cross-purposes. These major hypotheses are:

1. Changes of the central banks’ policy rates of interest have consistently powerful consequences. After the RBA reduces its OCR, for example, this country’s major stock market indexes generally rise.
2. Investors can, at least roughly, anticipate the RBA’s moves. Their anticipation of a rate cut(s), for example, will tend to boost stocks’ returns.
3. The RBA’s decisions to alter the OCR take into consideration a variety of information – including Australian stocks’ sharp rises or falls.

If Hypothesis #2 is true, then stocks’ returns will begin to rise well before the RBA cuts the OCR – that is, well before Hypothesis #1 expects. If so, then the evidence supporting Hypothesis #2 will weaken the evidence supporting Hypothesis #1. Conversely, the stronger is the evidence supporting Hypothesis #1, the weaker will be the evidence supporting Hypothesis #2.

In other words, only if investors don’t anticipate their decisions can the actions of central banks strongly and consistently affect financial markets. (This, in a highly simplified form, is why much American research focuses upon “surprise” changes of the Federal Funds Rate.)

Hypothesis #3 adds further reciprocity into the mix – which, as a result, is realistic but bewilderingly complex. The RBA influences the stock market, which influences the RBA; further, stock markets anticipate the RBA’s actions, and the RBA anticipates markets’ actions!

Implications for Long-Term Investors

Given reality’s bewildering complexity and inherent messiness, what’s a conservative, long-term investor to do? Over the past six months, Leithner & Company has expended time and effort demonstrating what we’ve long suspected:

• “experts” are unable to foresee the RBA’s moves with any reliable degree of accuracy (see in particular How experts’ “systematic mispredictions” improve our returns, 6 August 2024), and
• the impacts upon stocks of these unpredictable moves are at best slight, and effectively random.

In short, neither you nor I or any “expert” can consistently predict changes of the RBA’s policy rate; nor can anybody reliably foresee their (at best slight) impacts upon stocks’ returns.

These results reconfirm the wisdom of Leithner & Co’s typical allocation of time and energy: we devote most of our attention to the analysis of and issues related to the companies we own and seek to own – and mostly ignore the RBA, its occasional statements and actions, as well as experts’ incessant but futile attempts to foresee its decisions and their consequences.

Warren Buffett’s advice remains as wise as it is succinct: “if Fed chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years,” he told U.S. News & World Report (20 June 1994), “it wouldn’t change one thing I do.”

Peter Lynch, the manager of the Magellan Fund at Fidelity Investments from 1977 to 1990, later a best-selling author and most recently a philanthropist, stated in an undated interview on PBS: “(it’d be) lovely to know when there (will be a) recession (or a rate cut, etc.). (But) I don’t remember anybody (in 1982) predicting we’re going to have 14% inflation, 12% unemployment, a 20% prime rate, you know, the worst recession since the Depression ...”

“So,” he concluded, “I don’t worry about any of that stuff. I’ve always said if you spend 13 minutes a year on (macro)economics, you’ve wasted 10 minutes.”

Like Benjamin Graham, Warren Buffett and value investors more generally, Lynch sought to buy and hold quality stocks over the long term. For that purpose, short-term changes of macro-economic variables such as GDP, consumer price inflation and unemployment – and the central bank’s policy rate – are usually mostly irrelevant.

What matters greatly, and therefore deserves the vast majority of an investor’s time and energy, is the identification of those companies whose shares the long-term investor seeks to buy and hold indefinitely, and the sensible valuation of their shares. That’s a matter of “bottom up” rather than “top-down” analysis.

The “top-down” approach starts with conjectures about macro-economic variables’ future course – which are mostly unpredictable. On that basis, it proceeds to the effects of these changes (which are also random) upon classes of assets, sectors and industries, etc.; lastly (and usually cursorily) it considers individual businesses. It uses the unpredictable in a futile attempt to predict the unpredictable! The “top-down” approach is “garbage in, garbage out” – in other words, worse than a waste of time.

In effect, Lynch is saying: “you can’t predict central banks’ interest rate decisions, etc., so don’t even try. Nor can anybody else; so ignore them. Instead, ask yourself questions such as: ‘if rates rose substantially, would the companies I own (or seek to own) cope?’”

As in the rest of your life, so it is in investing: success doesn’t result from trying to peer into the future and thereby somehow eliminating risk and uncertainty. Still less does it come from heeding “experts” who’ve fooled themselves – and you – into thinking that they possess the ability to foresee events. They don’t know and they’re just guessing – but if they admitted it, who’d pay any attention to them?

Success isn’t a matter of accurate prediction, but of the realistic conception and management of risk (which in practice is largely unpredictable) and the acknowledgement of uncertainty (which by definition is unfathomable; see, for example, To lift your returns, swap these risks, 9 December 2024).

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