SustainAbility: What to do after the recent sell-off in equity markets?

The dog days of summer

The dog days of summer are the hot, sultry, days of summer. They have historically related to, as per Wikipedia, heat, drought, lethargy, fever, mad dogs, and bad luck. While anyone witnessing another disappointing British summer may feel disconnected from this idea, market participants may be able to relate to the madness and bad luck of markets recently.

The scale and speed of the recent sell-off in equity markets and rally in bonds has taken most investors by surprise. As always, share price movements drive narrative. The narratives forming today range from an impending US recession to an unwind of the Japanese yen / US dollar carry trade. Whatever the explanation, investors are staring at share prices materially lower than they were just days ago.

What to do? That’s the question most investors are asking. In our industry most ‘buying opportunities’ are buying opportunities, particularly in equities. The corporate world changes much less slowly, and grows much more steadily, than the investment world, and we have recently seen a good earnings results season. Of course, things can always get worse, but that isn’t an investment strategy.

Our bias is to selectively add to holdings into the recent weakness. We have minimal (one company – Shimano) exposure to Japan, whose market was down 12.5% in one day (it has subsequently recovered a reasonable amount of this). We do have exposure to the US and US technology companies which are also seeing material falls, however.

With respect to Artificial Intelligence (AI), the ebullience followed quickly by despair, followed by more ebullience, was seen when the internet came to pass in the late 1990s. New technologies always go through peaks and troughs of enthusiasm, and the skill is to not become over or under exposed in these times. There may now be an opportunity to ‘buy AI’ at a more attractive price.

As for recession concerns, there will of course be a recession at some point. Most investors thought this would occur last year, but it didn’t and some investors missed out on a year of strong returns. Will one occur this year? Maybe, but recent evidence is economic growth has been good and interest rates are now beginning to fall. Recessions are the exception, not the rule, in economies. This is worth considering when building an investment decision around the possibility of one and the consequences of getting that call wrong.

In summary, the last few days have been unsettling, but history suggests they are more likely to pass than not. It will take some time however, as confidence can be lost quickly in markets but is usually only regained slowly. Forced and panic selling, which it has felt like recently, does however help build long-term returns for those who can use them. Selectively that is what we have been doing, whilst keeping an open mind as to the range of possible outcomes in the coming months.

How to be a long-term investor

In my experience the most over-used claim by market participants is to be ‘long-term’. In my view, long-term as an investor should really be measured in decades, given most investors will begin their journey multiple decades before they need to harvest the fruits of their investments.

For professional investors, the decrease in investment time horizons has been the most notable trend of the last few decades. It has become much easier to buy and sell shares, and the media industry has gravitated towards short-term headlines and a ‘bad news gets clicks’ mentality. None of these developments have been positive as it has created an army of traders, not investors, and built a fundamental mismatch in how many investors invest and what drives long-term returns.

For equity investors, what happens in any given year should be relatively immaterial. For example, for a company whose shares are worth 20x its annual profits (or earnings as the industry calls them) each year of profits is worth 5% of the current share price. In theory, if that company made no money for a year, perhaps due to a recession, it should have minimal impact on the long-term value of the company. It would however have a major impact on its share price, which based on my experience could be down 30-50%.

What really matters in valuing a company and in long-term investing, is not what happens in the next few months, or even years, but what happens further out on the horizon. This is the premise of our approach to sustainable investing. When we look out many years, we expect to see a cleaner, healthier, safer and more inclusive society than we have today. We can also see many avenues to get there which the companies we invest in will thrive in creating value for their investors and for society. In this context, what value is there in trying to forecast recessions or understand yen carry trades?

Of course, the answer is not none. All investors need to be aware of economic, geopolitical, and other types of risks. These issues do however, over time, usually shrink in importance relative to societal progress and corporate profit growth. Unfortunately, media headlines do not support this. As one of my team astutely noted, no media outlet ever writes ‘billions wiped onto the value of equities’ which has been the actual story of the last two years.

The holding period for investments in our equity portfolios is currently around seven years. Even that could be argued to be too short-term if we are investing over decades. That said, we acknowledge the very long-term future is difficult to forecast (who knows what innovations will occur 15 years from now) so shorten it to time horizons we think we can reasonably understand. Seven years is however at the high end of the industry and peers, and we think it is in our investors interests to be so.

If, as an investor, you are struggling to be long-term then there are some things which can help. First, very few things are as important in the moment as they seem in time. Even Covid, the most invasive event that many of us have had to deal with, has found its respectful place in history and equity markets are higher than they were before it. We believe that becoming less sensitive to short-term events is a positive in investing.

Second, and as we have written before, we think that optimism is the only rationale mentality to have as an investor. There is no long-term investor in history, as measured in decades, in equities that didn’t have a positive outcome remaining invested in a broad range of good quality companies. To be pessimistic in the face of that is unlikely to be successful. Of course, there is a caveat. We must be able to judge the success of our investments over many years, not over a few months, or in today’s world of instant valuations, daily.

Interestingly in a recent interview, Magnus Carlsen, five-time world chess champion, noted being an optimist had made him more successful as a chess player as it had allowed him to see scenarios and moves that a more pessimistic bias would have missed. Investing is the same, being optimistic about the future allows us to see opportunities and gains that pessimists simply miss.

Regardless of the events of the last week, we remain optimistic about the future!

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.