Comment and opinion for retail investors in the UK
I have written a couple of pieces to introduce this subject and I had promised to comment on some specific funds last week.
However, I thought that the possibility that there was a ‘bottom’ in the market at that time (an idea that is still holding good, but it is early days yet) was a more urgent idea for your attention a week ago, so the global dividend/equity income fund examples got deferred.
As usual when starting this monthly commentary, I looked back to see what I wrote a year ago and in fact it was absolutely relevant on this occasion. I was prognosticating the potential impact of central banks raising interest rates to tame inflation. I took the general line that such actions might not be that effective based on prevailing conditions but that if the central bankers decided that the way to make rate rises more effective in slowing inflation was to ramp up rate rises, then they might crash the global growth completely.
I just read a piece by ‘Dr Doom’ , Nouriel Roubini, more or less saying that stagflation (inflation and no growth) was now a dead cert. He was able to add some extra negatives that I did not know about a year ago: the Russian invasion of Ukraine and the very aggressive lockdowns in China as the government there tries to keep the country free of a major outbreak of coronavirus.
During my first trip to the UK since the start of the Covid-19 pandemic, so over 2 years have elapsed, I made observations as one does about a grandchild or nephew that one has not seen for some time – noting changes that parents and those seeing the kids every day don’t really see as significant.
It was a short visit so I travelled across the South of England only and stayed in various B&B, pub and holiday lodge rooms. The main changes I noted were these, all I suppose consistent with ‘macro’ changes that have been predicted:
These are observations based on a short trip and pretty subjective, so I am not claiming them as gospel! Just my personal perceptions.
This is the main topic of my musing and this time I really am not able to propose a concrete interpretation of an observed major change in the way the investment world works, only to speculate on the implications.
A few years back I had a lucky opportunity to listen to the Nobel prize winning finance guru, Yale Professor Robert Schiller, lecturing at Vilnius University (his grandmother was Lithuanian). He is considered one of the fathers of the behaviourial theory of finance and he was talking about his latest research.
He explained that developments in the consumption and recording of words by the likes of Google has created all sorts of new analytical opportunities, some of which provide insights into the ‘herd’ thinking of the market that the behaviourists would argue drive market valuations. For example, one can pay to find out how often a word or sequence of words occurs in a Google search across a given period, or in all global published documents.
You might for example wonder if the world at large was interesting in investing in gold and you could as a result find it useful to see what the pattern of searches has been recently for the phrase ‘gold price today’. That information can be obtained in a very granular form. This is very similar to the idea of ‘trending’ on Twitter, views on YouTube and so on.
Such data can be requested by a machine and processed with other data by the same machine to create an analytical model which might even follow through into transactional activity – asset purchases and sales.
I learned this last week that the annual statements made verbally by the CEOs and CFOs of the largest businesses in the world, like the member companies of the S&P500 index or the FTSE 100 are immediately transcribed by AI programs on presentation (before they are even issued as printed documents) and searched algorithimically for key words and phrases, outputting instant analyis to humans or to feed into tranasctional models.
This trend towards automated analysis adds a layer of investment dealing between the traditional human, research led, objectives driven managed style and the popular low cost passive style that tracks a composite index of shares or bonds built from a set of rules and a source universe like a stock market index eg a FTSE ALL Share tracker or a Vanguard Lifestrategy fund
You may have heard me say that algorithms are never intelligent, quoting a US lawyer. This is something that can be exploited. Professor Schiller explained that the investor relations departments of large companies get to know what words or phrases are looked for by the analyst algorithms and they then plant these to their advantage in press releases and other publically available material! No doubt CEO periodic reports can be doctored the same way.
I am inclined to think that we now have 3 choices of fund management style: human and intelligent, passive and input free and finally automated and potentially gullible.
Naturally, I prefer to invest in the best of the managed funds, although finding them for the future is as much an art as a science. However, it helps to know that very large sums of money are flowing in and out of markets using the other 2 models. My current view is that this is helpful, offering a permanent underpin to values and may well explain why any systemic setback for over a decade has been speedily reversed. In other words the stock market has become a permanent sellers’ market.
But I am not sure. My intuition says that automated processes can go wrong and when they do, the blow up can be dramatic. What do you think?
I note that in previous years I have adopted a ‘first quarter end’ review approach in writing April briefings. That still makes sense to me – we are now far enough into the year to get a feel for what will make 2022 different in economic terms and we can get an idea of what central banks are likely to do to try and manage economic growth and avoid a recession.
I did some crystal ball gazing in January and identified a number of risks. Of the potential negatives, inflation and increasing geo-political tensions have turned out to be the two most significant headwinds, although increased US regulation is now coming through and we have not seen the back of Covid19 yet, especially in the Asia Pacific region.
One factor that I touted as a momentum positive, ESG investing, looks like being a little less of a useful guide short term than I predicted. As the war in Ukraine and the associated sanctions on Russian energy have pushed the oil price up, so have the price of energy company shares, which will not fit in the portfolios of investors whose ESG filters are focused on sustainable energy and fossil fuel free energy production. This is a subject I address in the second part of this blog.
I refer to the sharp sell off and loss of confidence in fixed income markets that I have been predicting for a long time would be the certain result of an eventual end to near zero interest rates, plus a realisation that if there is going to be inflation, one has to own ‘real’ assets, like global equities.
The latter asset class may suffer if central banks trigger recessions by misjudging the pace of rate rises, but at the moment, the relatively hawkish approach we are seeing suggests to markets that the top economists are confident in the strength of labour markets and consumer demand and see their priority as holding back inflation. Stagflation is no doubt a risk, but markets are not seeing things that way.