A top-to-bottom or top-down approach to investing lets the investor analyze the starting from the big picture all the way down to the individual stock.
This strategy is the polar opposite of the bottom-up approach, which starts with a specific stock’s fundamentals and then expands to the broader economy.
The Top, Global View
The first step in using the top-down approach is to start by determining the world’s economic health. You do this by analyzing not only the major, developed economies but also the countries that have emerging economies.
The faster way to look at a country’s economic health is to look at its gross domestic product, or GDP, growth over the past few years, as well as the estimates for the future.
Usually, the emerging market countries will show the best growth numbers when you compare them to other more developed countries.
After finding which regions offer a high reward-to-risk ratio, the next step is to use charts and technical analysis.
Looking at the long-term charts of the specific countries’ stock index will help you determine whether the corresponding stock market is in an uptrend. It will also show if that specific market is worth analyzing.
This step as well as the first one will help you discover and find the countries that will best fit the bill when it comes to your wants and needs in terms of diversification.
Looking at the Economy
Third step has more to do with more in-depth analysis of the US economy and stock market’s health. When you examine the economic numbers, like interest rates, inflation, and employment, you can get a better picture of the current market strength and gain a better insight of what the future holds for this economy.
You will find that there is often a disconnect between what the economic numbers show and what the stock market indices show.
Analyzing Stock Indices
The last step in macroanalysis is dissecting the major stock indices like the S&P 500 and NASDAQ. You can use both fundamental and technical analysis as barometers for this purpose.
You can determine the market’s fundamentals using ratios such as price-to-earnings, price-to-sales, and dividend yields.
It’s also a good idea to compare number from previous readings to help you determine whether the market level is historically overbought or oversold.
Technical analysis will help you know the market’s standing compared to its longer-term cycle. You can use charts to follow several years and then view the charts using the daily view.
The process will let you use a macro approach to the market and will help you determine your asset allocation. If you find that the results are bullish, you can probably put a majority of your investments in the equities markets.
However, if the results turn out to be negative, it will be wise to switch a big part of your investment to more conservative assets such as fixed income and cash markets.
Of course, the top-down approach isn’t perfect. To be able to really gain some benefits out of it, you need to spend time on it.
Also, there is a chance that your analysis will turn out wrong, meaning you can miss some huge opportunities along the way.