One debate about investing is – do share prices drive narratives, or do narratives drive share prices? Do we observe market movements and find a story to attach to them, or is it the stories themselves which drive market movements?
Markets themselves are significantly over analysed, as the media and investors seek to explain every share price move, every day. There are very few durable and long-lasting drivers of share prices and markets, with a very high proportion of day to day ‘news’ being nothing but noise. Most of the time if the market is up the true explanation is there are more buyers than sellers, and it is nothing more than that.
The narrative driving markets has been unremittingly negative over the last 18 months. A war in Europe, inflation is too high, interest rates are moving higher at a rapid pace, a recession is near etc. All of these narratives are valid of course, but they neglect other more positive developments. One of these is the development of artificial intelligence (AI) into Generative Artificial Intelligence (GAI).
GAI is the next stage in development of the broader area of AI. It is a term used to describe any AI system whose main role is to generate content, which can be text, images or sound. Previous forms of AI systems performed functions that were more data orientated, which included classifying, extracting and decision making. GAI will impact, both positive and negatively, a broader range of industries than AI has previously.
At the core of GAI remains many of the same principles of more traditional AI; a huge amount of information being crunched by immense computing power. Despite concerns, it is unlikely to replace humans, but it will make them more productive and allow time to be spent on more value-add tasks. For anyone worried that AI is becoming too powerful, it is still not close to being able to deliver autonomous driving despite years of development and millions of hours of training. A 17-year-old can learn to drive in roughly 20 hours. The human brain is a wonderful thing!
Is GAI enough to offset the negative concerns around markets? It could be if it improves human productivity rapidly and provides downward pressure to inflation and interest rates by reducing labour shortages. It could also improve corporate growth and profitability. Overall, in our view it is more sensible to view it not in a pessimistic light but rather as another, positive, variable to consider in the investment environment and a reminder that innovation and optimism can source investment return.
Theory and reality
Investing is an area of theories tested by reality. As the quotable Yogi Berra said, ‘in theory there is no difference between theory and practice; in practice there is.’
One recent theory was of a commodity bull market starting last year in part due to the need to mine our way to net zero, but also the removal of Russia as a major oil and gas supplier to the global economy. The other theory was that commodities would be a hedge against inflation. Neither of these has proven to be correct.
Oil and gas prices are now some way below what they were before Russia’s invasion of Ukraine, and the price of copper, the ultimate ‘mine your way to net zero’ metal due to its role in electrification, is down year to date and over the last 12 months. Share prices in these sectors have begun to follow their underlying commodity prices. Why are commodities underperforming?
The most obvious explanation is concerns over the economic cycle. Commodities are cyclical by nature and as concerns have grown over a recession in the global economy, prices have fallen. The re-opening of China after its Covid lockdowns has been led, at least economically, by its service sectors rather than, as historically has been the case, infrastructure and property investment. The latter is commodity intensive, the former is not.
With respect to oil and gas, there has been no shortage post sanctions on Russia as many countries remain willing to buy from it at discounted (up to 30%) prices. These countries include both India and China which have prioritised, rightly or wrongly, their own economic wellbeing and development over taking a stance on the war in Ukraine.
It is possible, if there is no recession, or if the war in Ukraine escalates, that commodity prices could recover. The more general investing lesson is that very plausible arguments and theories can turn out to be completely wrong. It is often better to focus on more predictable, observable trends than to forecast the creation of new ones. Durable trends last for many years, allowing successful investment in them long after they become established. Cloud computing would be a good example of this, which has remained a valid investment trend since 2013.
The price of time
‘The price of time’ is the title of a book by Edward Chancellor. It seeks to explain the history of interest rates going back many centuries and looks for precedent that can be applied to the current debate around monetary policy and the appropriate level of interest rates.
It is a well written book and very educational. In social media style, however, the TL;DR (too long; don’t read) summary would be there are ongoing philosophical debates going back many centuries as what the goals of monetary policy should be, and the appropriate level of interest rates.
The more objective part of the book is the evidence that economic troubles tend to follow prolonged periods of low interest rates, as these create imbalances and distortions in the economy which ultimately lead to bubbles and large-scale misallocation of capital. The book posits that we are in such a time now.
It isn’t hard to observe that this argument is proving to be at least somewhat correct today. The bursting of a technology bubble in 2022 and the recent issues in the US banking sector could be argued as reflective of problems created by low interest rates. As to whether this is the start of a broader trend of difficulties as higher interest rates are absorbed by economies and societies, only time will tell.
The overriding sense after finishing the book though is how much ambiguity there is about what is appropriate interest rate policy. Given this is one of the most important and analysed variables in investment decision making, it may have been assumed there is a bit more clarity about it. But then the degree to which forecasts for future interest rates were wrong back in early 2022 shows how little certainty there can be.
Current expectations for interest rates are that these have nearly peaked and will fall later in the year. It can only be speculation as to how accurate this will be.
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.