Alan Greenspan was the 13th chair of the Federal Reserve, occupying the office from 1987 to 2006. He was well known for his style of communication, which was honed over 19 years of congressional hearings.
In a 1988 speech, early in his tenure, he came up with arguably his most famous comment: “If I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”
This could easily be about investment markets now. If they are clear to you, then you’ve probably misunderstood them. In our last blog we discussed three likely scenarios for markets this year: we concluded each suggested a different portfolio and it wasn’t clear to us which one would prevail. Since then, markets have risen significantly – so what are investors thinking?
In the last few weeks, it appears that markets have increasingly been discounting what could be described as the ‘immaculate disinflation’ scenario, in which inflation eases back to long-term target levels without a significant or prolonged recession. This painless transition back to the world of pre-2022 investing, when all asset classes performed strongly, is an attractive proposition. It has been supported in recent weeks by evidence that inflation is indeed falling rapidly, helped by declining energy prices, and economic activity is proving more resilient than expected. This is a much more favourable scenario for financial assets than a deep recession to bring inflation down, or an acceptance of higher long-term inflation as the price of economic growth.
The optimism of immaculate disinflation has taken markets, at least temporarily, back to the days of 2021 with meme stocks and profitless technology companies being the best performers. It has also supported bond markets, which now expect interest rate cuts in tandem with falling inflation numbers. If 2021 was the everything market, whereby everything went up in value, and 2022 was the nothing market, when everything went down, then 2023 would take us back to 2021.
It is hard to know if this is justified; markets often only really make sense looking backwards. Although there is some bemusement about the recent rally in asset prices, that doesn’t mean that the market is incorrect. There was significant scepticism in April 2020 in the first weeks of the Covid-19 lockdown about the rebound in markets, but it became clearer as the year unfolded that the unprecedented speed and scale of the policy response of central banks – and the subsequent accelerated vaccine development – justified it. The ‘wisdom of crowds’, as represented by financial markets, seemed stronger than the conviction levels of individuals.
To reflect the wide range of potential outcomes, we think it wise to broaden out our portfolios into attractive investments that have different characteristics from our current holdings. We will have far more certainty by the end of this year what the long-term investment drivers (growth, inflation and interest rates) will be. This could very well set the framework for markets for several years to come. For now, we feel this is a market that Alan Greenspan would prefer us not to understand too clearly.
Lessons in contrarian investing
It is often observed that there are a limited number of investment approaches, of which most mangers choose one. Value, growth, contrarian and momentum cover most bases and it fascinates us that most investment careers are defined by which one a manager works in first. Like switching sports teams, changing investment styles is a controversial thing!
To a significant extent we agree with this. It is important that we are consistent in our approach to investing. Our four key principles have been unchanged for 20 years – products and services which make a positive contribution to society, good ESG standards, value creation and valuation. They are principles that can be applied to a wide range of investment opportunities, which we believe supports the long-term performance of our funds.
When it comes to the more traditional characterisation of investment approaches, we are growth investors who integrate valuation with an understanding of market trends. Contrarian investing is perhaps the one area with which we least associate ourselves. That said, it is a fascinating approach to investment from which much can be learnt.
To see the power of contrarian investing, consider the returns seen from markets since October last year. In October energy prices and inflation were out of control and expectations for interest rate increases reached levels not seen for many years. What has happened since then? The Nasdaq index is up 18%, the S&P 500 is up 17% and 10-year US treasury yields have fallen from 4.2% to 3.4%. It was a good time to invest. Welcome to the world of contrarian investing!
Of course, there are many lessons which could be taken from this. The main one is that the best time to invest is when the outlook seems the bleakest. This is when valuations discount the most negative scenarios and therefore offer the most upside if things change. Late-March 2020 during Covid is another example. Buying and selling investments is often more successful when going against the prevailing wind than with it (though you must also be cognisant of the risks of trying to ‘catch a falling knife’).
The way we try to use contrarianism is to understand that ‘many shall be restored that now are fallen and many shall fall that now are in honour’. Looking at parts of markets that have performed poorly is very helpful in identifying future successes – while understanding that trees do not grow to the sky helps us to challenge our existing positioning. Even though we are not contrarian investors in the purest sense, there is much to be learnt from this investment approach.
A postcard from results season
The fourth-quarter and full-year corporate results season has now begun in earnest, with the US and Europe leading the way. The UK will follow in the coming weeks giving a fuller picture of the global economy.
So far, results have been better than feared. Rumours of the demise of the consumer have proved exaggerated (or even unfounded?), with most retailers reporting good trading over the key Christmas period. Despite inflationary pressures, employment is still high and, particularly in the US, there is still significant amounts of unspent stimulus money in consumers’ bank accounts.
Another key issue has been the reopening of China. This largely unexpected event is providing a boost to Asia-oriented companies, most immediately in the consumer sector. After being locked down for three years, consumers in China have record savings and are very keen to spend them. Recent reports suggest, as the Unilever CEO described it, ‘revenge consumption’. This is something we saw in the US and Europe following lockdowns – and was inflationary as well as positive for growth.
Corporates have also dealt with inflation well. It seems much easier to pass price increases through to end customers in an 8% inflation world than a 2% one. This comes down to expectations, with inflation broadly visible in the economy it has a habit of feeding on itself, something worth bearing in mind when considering how it might remain sticky in the coming months.
Overall, there is not yet compelling evidence of a recession from the corporate sector, nor of falling inflation. We shall see what the rest of results season brings.
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.