In recent updates, we’ve made the point that the future is always uncertain and currently it is particularly uncertain.
As such, becoming too fixated with one particular outcome can lead to thought processes that are unhelpful in building an investment strategy.
Scenario analysis is a good way to avoid this. By accepting there are multiple possible futures, with the ultimate one only to be decided by upcoming events, it allows broader, less biased thinking to take place. These are the three scenarios we felt were most likely at the start of the year, and remain the most likely now:
- Economic growth is stronger and inflation higher than expected through a combination of China unlocking post Covid, the European economy being better than feared as energy prices have reduced, and unemployment being at multi decade lows with upcoming stimulus packages in the United States. Under this scenario bond yields could rise, equities may fall and returns on cash would look attractive.
- We witness what some have called ‘immaculate dis-inflation’ whereby inflation comes back to central bank targets without a significant economic slowdown. Under this scenario equities and bonds would perform well and there is minimal value in holding cash.
- We enter a prolonged and deep recession as the price of bringing inflation back to target levels. This would happen if interest rates were taken to a level where key drivers of economic growth, such as consumption, begin to fail. Under this scenario bonds and cash could perform well, but equities would come under pressure.
Over recent months we’ve seen markets flit between these scenarios. January was a month of scenario two and immaculate dis-inflation, as inflation reports showed a peaking and then decline in headline rates alongside resilient economic data. In February, scenario one began to appear, as many corporates reporting their financial performance and outlooks noted the economy was not slowing, and therefore some reports showed inflation not coming down further. Scenario three is perhaps the least talked about, even though it is possible to find data to support an economic slowdown occurring and it was the most favoured scenario in December of 2022.
From what we can objectively see, interest rate increases do not yet seem to have had the slowing effect on the global economy that some may have expected. Is it even possible to have a US recession with unemployment at multi-decade lows? With China, the second largest economy in the world, unlocking and Europe, the biggest economic region in the world, less impacted by high energy prices is it reasonable to expect global economic growth to slow and inflation to reduce? The answers to these questions will only be known in the fullness of time. In the interim it pays to keep an open mind and look for a range of investments which are attractive on an individual basis and in aggregate to reflect the broad possible range of outcomes.
What a three years!
On the 25 February this year, our Global Sustainable Equity strategy reached its three-year anniversary. We are pleased to say it reached this milestone in good form. In those three years we have seen a pandemic, a war in Europe, a collapse and then recovery in equity prices of historic proportions, a move in bond yields and inflation of historic proportions, and finally a collapse in speculative technology investments equal to the technology bust of the late 1990s. As the saying goes, there are decades when nothing happens, then weeks when decades happen. Here are some of things we have witnessed and learnt:
- What seems defining in the moment is much less so with the passing of time. The societal impact of financial crises, pandemics and inflation spikes are there for us all to see. But even these events, and others such as world wars and depressions, do not in the fullness of time stop the steady improvement in the society and the growing profitability of those companies who operate within it.
- No one can consistently predict the future. Whilst there are many views as to how the future will turn out, the last three years has clearly shown the perils of forecasting.
- Reward happens slow, risk happens fast. Some investments, particularly more speculative ones, can perform extremely well for many years, making their owners looks astute, but can lose all these gains in months.
- Successful fund management is an accumulation of sensible decisions, not single big calls. It would have been possible to take big positions on macro events for logical reasons and they be entirely wrong, for example in the initial stages of the pandemic.
- Sustainability, as described as helping transition to a cleaner, safer, healthier, and more inclusive society is an effective framework for continuing to operate in even the most uncertain times. In our view, it is highly likely, given their value to broader society, that companies helping to achieve this will see growing demand for their services whatever the economic climate.
There will be many more events in the coming years, the most important of which will not be largely forecast. We are hopeful we can take what we have learnt in the last three years on this strategy, and the preceding 20 years since we created our current investment process and use it in a productive way!
A postcard from the C-suite
One of the privileges of working in fund management is access to CEOs across a range of industries and geographies. Despite perceptions otherwise, they are normal people who have achieved abnormal things in their professional lives. The majority are decent and committed managers of large and complex organisations who must deal with many of the issues we see in everyday life.
What has come through in our recent meetings with them is a sense of determination and optimism that we think is sometimes lost in investment markets. Many of these CEOs have led their companies through the pandemic, Ukraine war and soaring inflation but treat problems like puzzles; they are there to be solved. Some ask us to stop reading the newspapers, which are often glass half empty in their interpretation of events. All believe the best years for the companies they manage are ahead of them, something we should all remember as the events of 2023 and beyond unfold.
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.