04 Oct 2023
As we head into the final quarter of 2023, macro headlines have begun to dominate the market narrative again. Oil prices have risen more than 30% since June and bond yields have risen. This is reigniting the concerns which dominated 2022, of higher energy prices and interest rates impacting economic activity and creating higher inflation.
This is a change from the first half of 2023, when micro dominated macro. In particular, the evolution of artificial intelligence (AI) into generative AI, which makes its use much easier and application much broader, resulted in strong performance from several stocks, and broader markets.
It isn’t unusual for markets to switch between being macro and micro driven; both are important variables in determining investment outcomes. That said, for equity investors, we are clear that over the long term, micro tends to be more important than macro. The creation of companies such as Amazon, Alphabet, Nvidia and many more, has been independent of inflation, interest rates and economic activity.
This is a particularly important point today, as the outlook for these key economic variables remains unclear and investors making decisions in relation to them are more likely to make mistakes. Yet at the same time the micro, bottom-up outlook for companies and industries has perhaps never been more certain. Key trends of decarbonisation, digitisation, and progression in cures for major diseases are progressing at pace, and the companies which will benefit from this are relatively clear. If our premise that long-term returns are more aligned to micro than macro trends, and that micro trends are clear, then it seems sensible to invest based on that.
After a period of stability, bond yields are on the rise again. The reasons for this are open to debate, but it is notable and somewhat contradictory this has happened at a time of falling inflation.
A positive reason for this is that the global economy has proved to be much more resilient than expected and is, overall, growing nicely this year. This means the bearish views on the global economy (higher interest rates, energy crisis etc) embedded in equity and debt markets at the start of the year have needed to be reversed. As this has happened equity markets have risen, and debt markets have fallen.
Less favourable interpretations including the recent rise in the oil price and wage deals, particularly in the US, are creating a future inflation problem. Equally, the levels of debt that governments had to take on during the pandemic, combined with continued budget deficits, means that buyers of government debt require higher yields. This debt sustainability argument is far from new, but it is getting some attention.
Higher yields provide challenges to the investment environment. As we wrote last year, nearly all assets are worth less in a higher interest rate environment, and in recent months we’ve seen asset price weakness move into the housing sector, having previously impacted debt, commercial real estate, and to a lesser extent, equities. Should interest rates plateau, as they largely did in the first half of this year, this is sufficient for markets to adjust, and for industry and company issues to drive share prices. If they continue to rise, concerns will remain about the ability of the economy to withstand them. Of course, interest rates could fall from here which would be a tailwind to asset prices.
It seems reasonable to assume that the 2010s were an aberration with respect to interest rates, and that we will return, and have already, to levels more like the 2000s and before. Although this will be a drag on markets and the broader economy whilst adjustments are made, it should pass, after which some of the strong investment trends we have noted above will become more dominant.
It has been noticeable in recent months there has been something of an anti-sustainability and net zero agenda appearing. The motivation for this is partly political, with it being seen at least in certain circumstances more electable to be against environmental initiatives; partly financial, as we understand the financial costs of decarbonising; and partly philosophical as some believe, as it always has been, that society can evolve into its problems without intervention.
Finance is a cyclical industry, both in an economic and investment sense. Nothing moves in a straight line and understanding and accepting the ebb and flow of finance is part of a successful strategy. This is different in areas such as science and engineering, where knowledge is built on knowledge in a more linear and organised way.
In this context, it is perhaps not surprising that after the increased interest in sustainability and net zero in recent years, there is something of a row back. It will certainly be an interesting test of the true motivations of anyone who has put forward their sustainable credentials in recent years. This is easy to do when opinion is in its favour, less so when it isn’t. We will be watching for signs of any corporates reducing their commitment to sustainability as an indication of true cultural change and progress in this area. So far, we have seen none in our sustainable fund range, but some oil majors are publicly reducing their climate goals.
Alex Edmans, one of our advisory committee members, often challenges us to think about what we would do if we couldn’t tell anyone about it, as a test of true motives. Would we invest sustainably if we couldn’t tell anyone about it, or it had no commercial value? Would we conduct engagement work if we couldn’t publish it? As a thought experiment, it is a powerful one.
Our reality is that sustainability has ebbed and flowed over the last 20 years that we have been doing it. Our commitment to it hasn’t changed though, and if anything becomes stronger the more the general interest lessens. This is because our investment insights become more valuable and our competition weakens. Time will tell if this happens again.
The investment implications of a reduced government commitment to the environment are interesting. When Donald Trump was elected, he campaigned on reinvigorating coal and other dirtier industries, and dialling down the green economy. In the four years he was president, the latter outperformed the former as the corporate and consumer parts of the economy decided to get on with progressing sustainability anyway.
Governments are clearly important, but they are only one part of the ecosystem which determines the future. Within the corporate world – the one we meet regularly – commitments to sustainability, regardless of whether they can be made public, are if anything growing as cultural change internally meets external business opportunities. We see little reason why this should change, providing a long-term favourable background for our funds.
This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.