How a company performs — and whether you deem it investment-worthy — comes down to more than just solid management and a strong competitive edge. What’s happening in the economy is hugely influential. Enter macroeconomics.
Macroeconomics is the study of those big economic influences: things like interest rates, inflation, and overall economic growth.
Even if you’re focused on the fundamentals of a company, like its cash flow and balance sheets, macroeconomics sets the tone for those fundamentals and shapes how they behave over time. That’s why it’s good to know which macroeconomic forces to pay attention to and how they can affect your fundamental analysis.
The big three: interest rates, inflation, and gross domestic product
Interest rates, inflation, and gross domestic product (GDP) have the biggest effects on a company’s performance. Let’s dive into how exactly they can shape fundamental analysis.
Interest rates
The Bank of Canada (or the Federal Reserve in the U.S.) sets interest rates to manage inflation and economic growth.
Rising and falling interest rates affect sectors differently. Here’s what that can look like:
Financials. Banks and insurers usually benefit from rising interest rates because they can charge more interest on loans and because the interest they pay on deposits doesn’t always rise as quickly. That widens their net interest margins (meaning they keep more of the difference).
Real estate. Real estate companies rely heavily on financing. When interest rates rise, mortgages and development loans cost more, which can reduce property values. Real estate investors also look at capitalization rates (returns on rental properties), which tend to rise with interest rates. Rising cap rates can mean falling asset values.
Technology. These companies are valued heavily on their potential future earnings. They’re usually considered growth stocks. When interest rates go up, the discount rate used in valuation models rises, making the potential high earnings of growth companies worth less today. That’s why tech stocks can be sensitive to interest-rate headlines.
When interest rates move, experienced investors will often shift their money between sectors, increasing their positions in sectors that benefit from the higher or lower rate and away from sectors likely to feel a hit. This is called sector rotation.
How interest rates affect fundamental analysis: Interest rates affect how expensive it is for a company to borrow or raise money, so it’s important to pay attention to debt levels and interest coverage ratios when rates are climbing. Also, high interest rates can increase the discount rate you’ll use in valuation models, which lowers the present value of a company’s future earnings. That’s why interest rate changes can dramatically affect stock prices, even if the company’s performance doesn’t change.
Inflation
The rising price of goods and services also affects sectors differently, based on how much or little they’re able to raise their prices without losing customers. This is called pricing power.
Here’s how pricing power can look across a few different sectors:
Consumer discretionary. Because spending on “wants” (like entertainment or restaurants) goes down when goods get more expensive, consumer discretionary is considered a sector under pressure during periods of high inflation. These companies have to risk losing customers with higher prices or trim their own margins to keep their prices extra competitive.
Consumer staples. Things like groceries are a need, not a want, so pricing power is higher for companies that sell consumer staples. But their margins can still be squeezed if their input costs (like packaging or transportation) rise faster than they can increase shelf prices.
Energy and materials. These sectors usually benefit from higher inflation because they are the inputs whose prices rise. Higher commodity prices can improve their revenue if production costs don’t rise even faster.
Utilities. The pricing of utilities is almost always regulated, which limits how quickly these companies can pass on any cost increases to customers. Their returns usually adjust, but not instantly.
How inflation affects fundamental analysis: Inflation can balloon revenue numbers, making a company look like it's growing even if sales are flat. And if a company’s costs (such as the materials it uses for production) rise faster than it can hike prices, its margins sink. Pay attention to margin trends in a company’s earnings reports [link to reports and earnings call article]. A company with strong pricing power typically has stable or rising margins.
GDP
GDP signals whether the economy is expanding or slowing down (contracting), which in turn affects demand.
Some sectors are more GDP-sensitive than others, most dependent on whether they are considered cyclical or defensive. Cyclical sectors rise and fall with economic conditions; defensive sectors are usually pretty consistent, regardless of whether the economy is expanding or contracting. (This is where some knowledge of sector analysis can come in handy.)
A simple rule of thumb:
When GDP is rising, lean toward cyclicals. Industrials tend to perform well due to more demand for new construction and equipment. The same goes for materials and energy, because there is a greater need for raw resources to support increased production demand. Consumer discretionary also fares well, because consumers are spending more freely.
When GDP is slowing down, lean toward defensives. Essentials for day-to-day life are well-protected. This includes health care, consumer staples, and utilities. Companies that offer essentials tend to have steadier cash flows, which lets them protect their earnings and maintain dividends when companies in other sectors might be struggling.
How GDP affects fundamental analysis: In a period of expansion, changes in GDP can help you evaluate whether a company’s revenue growth is coming from its own success or just a strong economy. When GDP slows down, cyclical companies may report lower earnings. You’ll want to look for signs that these companies can handle tough times. Do they have enough cash flow to cover debts and costs? Is inventory moving or piling up?
Why stock prices don’t always follow the fundamentals
Even when a company has strong financials and macroeconomics is on its side, the stock market doesn’t always reward it right away. That’s partly because of investing trends.
Instead of picking individual stocks, many investors today put their money into exchange-traded funds (ETFs) and index funds. These funds buy groups of companies all at once (like the entire S&P 500). This is called passive investing, because investors are tracking the market and not trying to choose individual winners.
How passive investing affects stock valuations
ETFs and index funds automatically buy shares of every company in that index or sector, regardless of whether each individual company’s fundamentals look strong or weak.
That means:
Stocks in the same sector often move together.
Both weak and strong companies can get a boost simply because of the volume of shares purchased through the ETF or index fund. And if money moves out of the fund, the opposite happens.
More passive investing = more stock price movement driven by the flows of a fund, not by business performance or macroeconomic factors.
This also shapes companies that aren’t a part of indexes. Because they don’t benefit from the same effect, they might have solid fundamentals but slow price movement, and get less attention from analysts and in news headlines. Investors who are willing to go outside major indexes and self-select individual stocks might be able to capitalize on potentially undervalued stocks.
What it means for fundamental analysis
The rise of ETFs doesn’t make fundamental analysis less important, but it does change how a company’s fundamentals are reflected in stock prices.
A high-performing company may lag behind if it’s not in a major index.
Stocks might move in groups, even if the businesses are very different.
It can take longer for the market to recognize strong fundamentals.
That’s why thorough fundamental analysis paired with an evaluation of macroeconomic factors can pay off for patient, self-directed investors.
How to integrate macro analysis into fundamental analysis to make decisions
Knowing how macroeconomic factors can affect a company’s performance is step one. Step two is learning how to pair that knowledge with fundamental analysis to inform your investment decisions (without becoming a full-time economist).
Build a simple macro dashboard
Create your own dashboard for key economic indicators. In addition to the big three (interest rates, inflation, and GDP), you might also want to track unemployment (which can add further context for consumer spending levels and a company’s reported sales) and consumer confidence (which measures how willing consumers are to buy).
You can check these indicators on a monthly and quarterly basis, using resources like government and central bank websites, major financial news outlets, and economic calendars, which provide a schedule of financial and economic events that could influence the market (such as the release of GDP reports and planned interest rate changes).
Connect macro trends to sectors
Remember to consider how macroeconomic factors affect sectors differently. When you’re pairing your macro analysis with your fundamental analysis, ask yourself:
Does this company’s sector benefit or suffer in this economic environment? How might that be reflected in my analysis?
This helps you avoid companies operating in tough conditions, or at least time your investment decisions accordingly.
Use timing tools to sharpen your entry
Another way to time your decisions: add technical analysis to the mix.
Fundamental analysis helps you decide what to buy. Macroeconomic analysis helps you figure out if it’s generally a good time to buy. Technical analysis can help you narrow down the best timing, based on how the market is behaving.
Look at technical analysis indicators like:
Trend direction. Is the stock price generally moving up or down?
Support and resistance levels. Where does the stock price usually bounce or stall?
Volume. Are investors buying confidently?
If your fundamental analysis looks good and the economic outlook looks supportive, but your technical analysis tells you the stock is still trending downward, waiting for a trend reversal can help you avoid buying too early.
Adjust your position size based on certainty or uncertainty
Depending on what your macroeconomic analysis tells you, you might want to adjust the size of your positions based on the confidence of the economy.
If interest rates, inflation, or GDP are in flux, a smaller position can help you mitigate your risk until the economy stabilizes.
When consumer confidence, employment, and GDP are high, larger positions can offer more upside.
But remember: macro factors affect sectors differently, so consider where you’re invested alongside how much you’re invested.
Protect yourself from big macro surprises
Growing signs of a recession, surprise rate hikes, and even things like natural disasters or political uncertainty can all create sudden shifts in the macroeconomic environment.
To soften the potential blow to your portfolio, employ some simple hedging strategies to help you sail smoothly across any volatility:
Make sure your portfolio is well-diversified across sectors.
Add stocks from defensive sectors to boost stability during economic slowdowns.
Consider using stop-loss orders (an automatic sell order if a stock price drops too far) to mitigate your risk if conditions suddenly get worse.
You don’t need to predict or analyze every economic twist and turn. But layering an awareness of macroeconomic factors on top of your fundamental analysis can help you better understand why a company might be experiencing a boost or decline in performance, avoid risks that might not show up in an annual report, and time your investments for when the economic environment will work with you and not against you.
