SustainAbility: Buy the dip?

Markets have fallen in the last few weeks. We’ve seen a combination of higher-than-expected inflation in the US, a function of a strong economy, and heightened geopolitical tension in the Middle East.

This has pushed equity investors to take profits after a strong start to the year and led to weakness in bond markets. The question is whether to buy the dip.

The issue investors are facing is that the US economy is proving to be stronger than expected. Expectations of a hard landing for the US economy last year were replaced with expectations of a soft landing, which was replaced with expectations of no landing, which is now being replaced with forecasts of above trend economic growth. With US consumers seeing high levels of employment and record wealth via equity and home prices, and the US government enacting a massive industrial policy through the Inflation Reduction Act and deficit spending, it is no surprise economic growth is better than expected.

A bear market makes buying a dip a mistake for equity investors and correct for debt investors. In my experience, these occur due to recessions – whereas now it would appear we are dealing with a stronger, not weaker, economy than expected. The consequences of this are important as it could suggest that equity markets should rebound but debt markets may not.

Equity markets are ultimately driven by corporate profitability, should continue to grow if the economy does. Debt markets are driven by growth and inflation expectations, and with both moving higher, yields would be expected to move higher, and bond prices therefore fall.

Equities also benefit from the big investment themes of AI and infrastructure investment in a way that debt markets do not. This can provide them extra support irrespective of the economic situation.

Forecasting markets is a difficult task, and their complexity is higher now than ever. Looking at company and industry trends often provides more insight as to what to do. That said, on balance, I believe that it seems more likely than not that buying into the ongoing dip in equity markets is the right thing to do.

Rotation is back

Readers may remember the key investment debate of 2022, which in equity markets was around value versus growth investing. As this blog noted at the time, whilst this comparison of investment approaches has some validity, it must be used with care. Value and growth investing are not as distinct as they were when I started my career in 1999. Value is a component of growth investing, and the opportunity set for value investing has arguably shrunk given the structural increase in innovation-led disruption across a range of industries.

Characterisations of stocks as value or growth, and their inclusion in such indices is also fraught with issues. Meta (once known as Facebook) has been tagged as a value and a growth stock in recent years, often depending on its short-term operational performance. Microsoft has at times been included in both growth and value camps at the same time! What is value and what is growth is as much in the eye of the beholder as the fundamentals of the business.

In 2023 investors ultimately moved back into what is tagged as growth investing, after a year of value investing, as the twin forces of AI and infrastructure spending became too large to ignore. This continued into Q1 2024, but in the last few weeks we have seen something of a reversal back into value.

Rotations within a market are one of the more bemusing things for fund managers to witness. That one bucket of stocks can be seen to be more or less attractive than another in any given time period – without reference to the underlying prospects of those companies – seems one of the less effective ways to think about managing money.

This said, it isn’t completely without logic. For example, in a higher interest rate world, cheaper stocks (and we would argue lower quality companies) become relatively more attractive than more highly valued stocks (represented by companies with better prospects). Also, certain industries group into these buckets. Commodity stocks are usually in the value bucket, therefore if investors become more optimistic about this area value performs better.

In the last few weeks, the strength of the global economy, combined with heightened inflation expectations and geopolitical tensions, has caused a market rotation into value and away from growth. As always, value investors will make the case this is logical given the valuation differential versus growth and the prospects for businesses within this area. Growth investors will say this may be true today, but weaker business models will ultimately undermine value versus growth, much as it did in 2023.

In my view, there is no need to take sides in this debate. Keeping to a core set of principles, both financial and sustainable, and applying them across the widest possible universe of opportunities is a much more reliable way of delivering investment performance than rotation. Our sustainable strategies will have a growth bias to them, as we believe there are huge opportunities for the companies we own to solve sustainability issues whilst at the same time growing their profits. If we can find these opportunities in areas others may define as value (but in time will be seen as growth) all the better. Equally if we can buy growth stocks at lower prices as value is in vogue, then all the better too.

Investing is tricky

Progressing through the various stages of an investment career, from ‘novice’ to ‘experienced’ then onto ‘seasoned’ and ending up as ‘stalwart’ is a strange experience. The days can go slowly but the years fly by.

In the context of our industry, it becomes an obligation of the seasoned investor (I’m refusing the stalwart label for now) to try to impart their learnings to new investors learning their trade. Investing – how hard can it be? Very is the answer, but not always for the reasons we might expect.

Perhaps the hardest part of investing is being long term; what brings long-term success often contradicts what brings short-term success. Delivering good long-term performance often involves owning (and not owning) investments which detriment short-term performance. Commodity companies, many of which have no long-term track record of delivering investment performance, may do very well in the short term. But over the long term they have not yet been a path to success. Investors say they are long-term, but can they be long term? Turnover rates in our industry suggest not.

Being rational is the other difficulty. When Charlie Munger, Warren Buffet’s partner, was asked what the most important characteristic of successful investors was, he said one word: ‘rational’. The ability to be objective, balanced, and unemotional in the face of markets is indeed hard. We are humans after all. But it is a goal we should all set ourselves. One simple example of this is, rationally, as prices go down investors should want to buy, and when they go higher, want to sell. Most investors are not rational though and think the other way round.

Think and be long term and be rational. Add in an optimistic bias and this is a great roadmap for success.

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.