October was a bad month in global equity markets. One of our benchmarks is the MSCI World index of stocks. It returned -5.44%. That’s the worst single month since we re-launched this strategy in May 2012. Our other benchmark is the median fund in our peer group. That peer group is the Investment Association’s “Global” fund category. The story is the same there: that median fund returned -6.56%. That’s the worst single month since May 2012.
Our investors will know that we are generally disinterested in movements over short time periods. We also tend to leave macroeconomic pontificating to others. But this month’s big move has naturally prompted an unusual level of interest from investors. Therefore, this month we are sharing our thoughts on what is happening and what it could mean for this strategy in the future.
There are many causes of this big sell off. We identified a few of them in last month’s newsletter. Growing trade tensions and slowing economic growth prospects are playing a part. Wage inflation and rising commodity prices will pressure corporate profitability.
In September these forces were visible in financial commentary. They impacted sentiment, driving share prices down, particularly in cyclical industries. October by contrast is a reporting month. So we heard from the companies themselves and its pretty clear that they didn’t say enough to reassure the market.
The general tone of management commentary has been sanguine. But there’s definitely a slow-down in some important industries, such as cars and consumer electronics. With the market in a jittery mood, even small bits of bad news prompted sharp declines.
So there are macro-economic reasons for fear, and the reporting season was a catalysing event. These are not trivial factors. They could on their own prompt a sharp reversal. But there is another factor at play here too, one which is probably even more profound. We are now, in the USA at least, in a rising interest rate environment. Widespread data points of inflationary pressure suggest we should expect continuing increases from the US Federal Reserve.
The exact path is hard to forecast. Growth, and inflation, in the world outside the USA is still scarce. Weaker growth on its own might reduce the need for rate rises. In a striking break with protocol and common sense, the President of the USA is also openly pressuring the Federal Reserve to keep rates low. A rising interest rate environment is without doubt something new for many in the equity markets to digest. Bond yield cycles are generally very long. The last peak in the USA was in September 1981; the trough was July 2016. That reducing yield cycle supported four or five major equities cycles.
So in October, while macro-economic prospects and company reporting collided, this new fear compounded the sell-off. But the impact of this paradigm shift will be felt over longer than a single month. The rise in equity markets that started in March of 2009 looks more and more vulnerable. Other things being equal, higher yields bring equity market valuations down and can also introduce risk and volatility.
Which brings us back to the impact for sustainability investing. In a less certain and less forgiving equity environment, differentiated companies will count for more. Short-termism will increase, and volatility will be greater. But over the long term, stronger fundamentals will dictate share price performance. Providing a proven solution to a sustainability challenge is a strong foundation for any company. This strategy should be well set to sail through these short-term volatilities. It will do so by holding differentiated companies with strong environmental and social impact.