The path of inflation in 2023 was always going to be one of the key determinants of asset prices.
After being shocked by its rapid increase in 2022, both investors and central banks have been attempting to reset expectations and strategies in relation to it. Its most obvious consequence has been the rapid rise in interest rates – with much debate about the timing of the end of those rises and the levels they will peak at.
On the way up, inflation was a global phenomenon, driven by high energy prices and tight labour markets. On the way down it has been much less uniform, with recent data showing inflation falling more rapidly in the US than the UK.
There has been surprise at the resilience of major economies in the face of higher interest rates and cost of living pressures. In the consumer world, money saved during the pandemic and associated government stimulus measures have meant that lower disposable income has been offset by high levels of savings. In the corporate world, businesses have been adept at improving their cost bases and increasing prices to offset input cost inflation. Employment levels have remained at near record highs. This has not helped the battle against inflation.
The UK is perhaps the first economy at a significant fork in the road, which we have written about previously. Inflation data published in June showed that inflation remains stalled at a high level, with core inflation (ex food and energy) above 6%. If the Bank of England wishes to meet its 2% inflation target it may have to move interest rates materially higher than they are today, to create a recession which will ultimately reduce demand in the economy. Alternatively, it may have to accept a higher level of inflation as the price of a stable economy. This is not an easy choice. It is possible other countries will follow in having this dilemma.
Standing back, we think we are moving from a time when inflation was benign (the 2010s) and central banks could stimulate at the first sign of economic weakness, to a time where inflation is a much less co-operative variable for policy makers. Whether it be structural labour shortages, which may or may not be solved with AI, higher energy prices or rising geopolitical tensions, some of the factors which created the benign inflation in the 2010s look less favourable. This is suggestive of a return to economic and market cycles, which for those managing money in the 2000s were a frequent occurrence. Should this occur, it will create new challenges and opportunities for governments, policy makers, and investors.
What is working
As fund managers, we create our own investment identity which we imprint on markets. This identity can be a function of objective evidence as to what delivers performance in the long run, beliefs such as the importance of sustainability and the strengths and weaknesses of the people who are enacting it. Done thoughtfully and applied consistently, we believe this is the path to long-term investment success.
Alongside this we are market observers. Each day there is messaging from within and across asset classes as to what is occurring in the global economy. Sometimes this is right, and sometimes this is wrong, but it is always worth paying attention to. What are the trends in the global economy that markets are pointing to today?
The clearest messages we can see are that we are entering into something of a boom time for both the physical and digital worlds. In the last decade, the physical world has been somewhat left behind by the digitisation of large parts of the economy. This has created many of the technology giants we know so well. Investment in physical infrastructure has lagged, but this is changing.
The key trends in physical infrastructure include electrification, a consequence of a desire to decarbonise, and onshoring, which is a consequence of rising geopolitical tensions and a desire to have industrial and manufacturing capacity at home rather than abroad. We have seen this most prominently in the United States, where the Inflation Reduction Act (climate investment essentially) and CHIPS Act (semiconductor manufacturing) have created material incentives to invest in the physical world. Those companies which help build it, such as Ferguson, Trane Technologies, Top Build and Comfort Systems have all performed well as investments because of this, despite some lingering concerns over the economic cycle.
The digital world also continues to progress rapidly. After a pandemic and remote-working-induced spurt of growth there was a feeling last year that the trend had run its course for the time being. Then ChatGPT and Generative AI came along. This would appear to give large numbers of extra use cases for technology in our workflows and everyday lives, with many of those using it describing it as transformational. Like all technology, it is likely we will overestimate its short-term impact, but underestimate its long-term impact as it changes the nature of work and levels of productivity. We will need more computing power and software, which explains to some degree the recent performance of stocks such as Nvidia and Microsoft.
For those confused or concerned about the macroeconomic outlook, we believe that these two trends of infrastructure build out and greater use of the digital world provide a practical roadmap to a potential investment strategy.
A message from the corporate world
One of the privileges of investment management is the ability to meet CEOs across a wide range of industries and geographies to ask and hear about the companies they run and the opportunities and issues they see. At any point in time it gives a great insight as to what is occurring in the world but, just as importantly, it helps in understanding the difference between the corporate and investment mentalities, which although linked through equity and debt markets are very different. Here are a few things I’ve learnt:
- The corporate world moves a lot more slowly than investment markets. Share prices can move up or down 10% quite easily without any discernible change from what is going on within a business. Making conclusions from share price movements as to what is going on in the corporate world can often be wrong as CEOs themselves are often bemused by them.
- CEOs are much more optimistic about the future than investors. At times working in investment markets can feel like working in world of pessimists. As one CEO commented to us, we don’t have the luxury of time to worry, there is too much opportunity out there and we must get on with managing our business.
- Many CEOs feel that sustainability is more important to their businesses that investors realise. Strong sustainability performance improves the ability to recruit talent, provides enhanced opportunities for new business wins, and reduces costs. The alignment between sustainable performance and financial outcomes, which is still debated within the investment industry, is much clearer to the corporate world.
We tend to find that CEOs are optimists, problem solvers and creators of the future. These are all things the investment industry can learn from.
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.