Quantitative easing and macro factors keys to investment success

The American comedian Will Rogers provided sage advice about investing: "Don't gamble. Take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it."

The key to that phrase, "buy some good stock", implies a somewhat outdated style of investing: to buy stocks and bonds of issuers with strong fundamentals. Many a fund manager swears by such a "bottom-up" approach, by which they buy firms with high quality earnings, governance and growth, on the expectation this will eventually be expressed in a rising share price.

The problem is macro factors dominate today's markets. Most particularly, the global regime of zero interest rates, often delivered on the back of quantitative easing, colours most markets and affects the valuation and performance of all firms, both good and bad.

Look, for example, at the case of corporate earnings, or what is typically the key driver of a firm's share price.

In a period of low growth, profit margins and cash flow improve perversely. Initially, companies cut costs to improve profitability. As revenues are stagnant, companies have no need to invest in expanding capacity or working capital, thereby releasing cash. Reduction in depreciation charges and the ability to use cash flow to cut debt lowers interest costs, as do sharp decreases in interest rates.

Cost cutting, productivity improvements and restructuring don't last forever. In the long run, increases in profitability require revenue growth. But lower growth translates into lower demand, which slows revenue increases. Lower demand and overcapacity in many industries have cut corporate pricing power, lowering profits.