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Top down fundamental analysis

Top down Fundamental analysis

The other school of fundamental analysis is what we call ‘top down fundamental analysis’. This is where we look at the broader economic, political or socio-economic influences on an economy, or what we call macro drivers. These macro drivers often affect the economy right across the board, rather than affecting any particular company or asset.

A good example of a macro fundamental driver would be a change in the short-term interest rates that are set by central banks. If a central bank decides that short-term interest rates should be raised due to inflationary pressures, this is going to affect the whole economy. When a central bank raises short term interest rates, they are basically raising the cost of doing business. So, one could argue that each company within the stock market is going to have their profit margin squeezed. This is a top down, or broader market sense, influence. After this, one could do a lot of new bottom up analysis on each individual company based on the greater cost of doing business. But the interest rate policy event itself is very much a top-down macro driver.

Another example would be something like war. War often injects a lot of uncertainty into the market. So, what happens is that both consumers and businesses themselves put purchases on hold until the war passes. However, sometimes these events can have horrific economic consequences.

So, to recap very quickly, bottom up fundamental analysis looks at very company specific aspects and drivers while top down fundamental analysis looks at broader economic, political and socio-economic influences.