February 2022 commentary – James Sym
There is only one topic to be discussed this month, and that is the appalling humanitarian situation in Ukraine. No doubt every single one of us is moved by the events unfolding and to talk about investment at such a time seems incongruous at best.
Yes, the ramifications of these last few weeks instinctively feel historic. The scale of the implications from an investment perspective directly from the Ukraine invasion, though, are perhaps less clear on a medium-term view. Yet I would caution against seeing these recent events as somehow the dawn of a new era or a line in the sand – rather they are a manifest continuation of a changing world order: away from the disinflationary, neo-liberal, rules-based globalisation under American hegemony of the last 20 years which engendered ever looser monetary policy, and towards a more fragmented system with more naked nation-state (or supranational) competition driven ultimately by popular dissatisfaction with the increased inequality said world order (and monetary policy) produced. This is important because it has – in a very stop-start way, initially – been changing the investment paradigm as well, in a manner which is becoming more apparent as time goes by.
Since the Global Financial Crisis, the investment train has headed in a clear direction with which we are presumably all familiar. Frankly, it has all been very easy. Beating inflation with any asset mix was straightforward. Profitability was a nice to have but certainly not essential in a world of excess liquidity. Duration risk was not a risk but a strongly positive return factor in both equities – seen in the outperformance of the growth style – and other assets. An early sense that this started to change was the Brexit vote and subsequent reflation trade on the election of Donald Trump in 2016. These were early outward examples of how the investment paradigm might be shifting, although clearly the trade war and then especially Covid meant that this period was a mere bump on the track for several more years as the train rolled on.
The investment train in the post-pandemic period is likely to head in a very different direction. The geopolitics – of which Putin’s Ukraine war is an example – is going to create a balkanisation of supply chains and labour markets which can only be inflationary, as is the necessary and highly-desirable energy transition. Debt levels are high of course, but in a world without disinflationary pressures, continuing with extremely loose monetary policy to allow a smooth servicing of this debt, risks a further, and potentially very significant, drop in living standards for ‘Main Street’ which is the very reason the world order is changing as discussed. It is therefore not sustainable, which is why we are convinced the investment paradigm is shifting. Debasement seems the most likely and probably least bad option, but that will come at a cost (in terms of the cost of capital) even if nominal growth in earnings may be solid in certain areas. Bretton Woods breaking up in the 1970s is a relevant analogue. In short, it’s about to become a lot harder. I believe that populating portfolios with assets which can thrive in this environment - namely value-orientated equities (limiting derating risk) in consolidated (pricing power) upstream assets (which protects value in real terms) which are likely to have a much better cycle than the last one, such as enablers of decarbonisation in carbon intensive sectors – is consequently the best course of action. Clearly valuation is only one part of this. These stocks could well be the Zooms, Amazons and Teslas of the next cycle.
This mix should at least protect and hopefully even benefit from the more difficult investment regime outlined that we appear more and more likely to be entering; it also hopefully describes the European portfolio we have built. Unfortunately, incumbency bias means clients predominately remain vastly overexposed to the sort of assets, companies and funds which have done well on yesterday’s investment train despite the obvious and increasingly frequent warnings ‘Mr. Market’ is giving. A colleague likes to quote Ray Dalio, “In paradigm shifts, most people get caught overextended doing something overly popular and get really hurt.” All change please!
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