SustainAbility: Melt up or melt down?

The last few weeks have seen a material shift in the investment environment, with several events occurring which demand some consideration.

First, and somewhat uniquely, we have the three major economic regions of the world, the US, Europe and China, all putting stimulus into their economies when they are observably growing quite nicely. The US is currently growing at around 3%, China 4%+ and Europe 2%. Stimulus is usually countercyclical, increasing in times of economic weakness, not procyclical, where you add stimulus in the good times.

Second, and more specifically to China, the government was previously ambivalent to problems in the property and consumer sectors given that overall economic growth led by exports has been okay. Now, however, the government is talking about making tangible steps towards supporting these important parts of its economy. This is a significant change in policy, and whilst the precise details are not yet fully known, it is a material event helping push the Chinese stock market up 25% in less than a week.

Finally, tensions in the Middle East continue to rise. Given that around 30% of oil production is in this region, escalating tensions can have an impact on oil prices which are an important variable in economic activity. Higher oil prices can lead to recessions.

Of these three variables, the first two – stimulus generally and then what China is now doing – are positive for risk assets. All other things being equal, which they rarely are, economic growth and corporate profitability, two key variables in equity prices, will be stronger than markets would have expected a few weeks ago. Of course there are downsides too, inflation would likely be higher too, but overall, it is a favourable scenario.

Rising geopolitical tensions, taken to the extreme, would not be good for risk assets, however. While no one can forecast what will happen in the Middle East, there are some concerning scenarios which could play out. In my experience and career, however, geopolitical tensions have always subsided so from a market perspective are buying opportunities. I think that this will remain the case, but there is always a risk involved.

Overall, and adding in the wave of productivity enhancing innovation happening in the global economy, a melt up in markets seems much more likely than a meltdown. Strong economic growth, increasing stimulus and high levels of innovation is perhaps most comparable to the late 1990s. At that time, interest rates were also being decreased due to concerns over Y2K IT risks (remember that?) at a time of good economic growth and strong innovation. Between 1997 and 1999 the US stock market rose by over 50%.

I am not suggesting this will happen again, nor am I suggesting this is necessarily a good thing in the long term, but it is a scenario which has some credibility. I think it is the scenario that will be discussed more widely if geopolitical events begin to calm down.

Markets are the ultimate investment teacher

Experience and age are interesting topics when it comes to investment success. There is a general view that both are positive, not just in investing but in nearly all professions. For those in non-physical roles, ‘a good old one will beat a good young one’ is the usual mentality.

Of course, age and experience does not give any rights or default superiority in investing. We can be prisoners of our experience as well beneficiaries. A good example of this would be after the technology bust of the early 2000s, where many of those who witnessed it became too reticent to invest in the technology sector and missed out on the exceptional returns from the internet and cloud computing, ‘Big Tech’ stocks. Equally after the financial crisis, many investors became too risk averse and missed out on the great equity bull market of the 2010s. Experience is neither good nor bad – what you do with it is what counts.

In that spirit, there are significant benefits to longevity in markets. They teach you lessons by being a constant feedback mechanism both for your own decision making and for economic and corporate events which happen on a regular basis.

True investment success is built from the aggregation of sensible investment decisions, not from trying to hit home runs.

Here are some of the best lessons markets teach us all:

• Success in the long term often requires us to make decisions that may be a detriment in the short term. Buying what is in favour at any given time can work, but buying what is out of favour that may become more popular is where the big money can be made. Recent events in China, noted above, are a lesson in this.
• Macro beats micro over the short term, but over the long term, micro always beats macro. What happens at an industry and company level is MUCH more important than inflation, interest rates and economic growth. Markets taught us this in late 2022, when the emergence of generative AI more than offset recession concerns and began a new bull market in equities despite rising interest rates and inflation.
• Patient optimism beats impatient pessimism. Delivering long-term investment returns requires a lot of patience. Compounding, as they say, is the eighth wonder of the world, but it takes decades to achieve and ideally is not interrupted. Equally there aren’t many rich pessimists in the investment community. Over time, economies grow and corporates grow with them, resulting in an upward rising equity market punctuated by one-off events. A long-term chart of equity markets teaches us this.
• True investment success is built from the aggregation of sensible investment decisions, not from trying to hit home runs. Investment returns are a function of how much money you make less how much money you lose. Managing both sides of this equation is important. There is no value in being right for nine years and losing it all in year 10. We can see this in the implosion of the technology boom in the late 1990s, and to a lesser extent in 2022.
• Most news, and I would estimate that to be 99%, isn’t relevant in the long run. Things that seem important in the moment are rarely important as time passes. Even the most extreme events – from pandemics, financial crises, recession, wars and much more – fade into the distance as time passes and do not impact the long-term case for owning equities. The Covid pandemic, as a market event, is the latest demonstration of this.

Of course, there are many more lessons. Learning new lessons, and relearning old, is a critical part of investment success. But in my view, the experience of being an investor over many years is on balance a positive, so long as it is used in the right way.

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.