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12th September 2023
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From Steven Lloyd, Investment Director, Ascot Lloyd

Since we typically take a break in August, it has been a while since my last commentary. However, after reflecting on various index levels at the end of July, and again at the start of September, a quiet and mostly flat month seems to have passed, yet further investigation evidences a continuous descent for most assets over the first three weeks.  This serves to remind me that many of us spend too much time analysing short-term anomalies, rather than long-term trends, but more on this later.

Investment commentary has a habit of recalling economic and political events over the month, in turn implying some cause-and-effect relationship – stuff happened, and this is how markets were affected. However, correlation is not causation.  Having been on-course for the worst month of global market performance for over a year, news of a new Rolling Stones album may be cause for celebration but (probably) didn’t inspire the rebound in market sentiment over the final third of the month.

Ratings agency Fitch downgraded the quality of US debt at the start of the month but whatever the immediate reaction, this is largely irrelevant – the US remains the world’s richest nation (enhanced by China’s fall from economic grace) and the dollar continues to play the role of global trading currency.

Investors continue to be mesmerised by any data that might signify a turning point in central banks’ interest rate strategy.  US inflation data was benign if inconclusive, yet bond yields continue to rise (and thus prices to fall).  In the UK, headline annual inflation fell by more than a percentage point, driven by falling gas and electricity prices. However, the falls would have been greater were it not for hotels and airlines’ prices rising strongly as the summer holiday season got into full swing in July, further supporting my view that much of our current inflation is being expanded by corporate (ie profit-led) price rises rather than raw material costs or supply chain issues.

August shop sales data showed a small increase in the value of sales, but Barclaycard data showed a slower growth in spending. This data conflict perhaps reflects fuel sales and restaurant spending and suggests profit-led inflation has eroded household spending power.  Summer holidays remained a UK consumer priority—spending on air travel was strong despite higher prices.

Perhaps most significantly in the near-term, Russia and Saudi Arabia confirmed that erstwhile temporary oil production cuts would be extended through to the end of 2023.  The price of oil has returned to $90 a barrel because of expected narrower supply.  On the face of it this implies upward pressure on inflation to recur.  However, the price is merely where it was in April, and OPEC+ members have been quietly cutting production for almost a year. If the global economy is slowing, demand will be less in any event – thus Russia and the Saudis are simply ensuring prices (and their respective revenues) remain firm.  It is also the case that where needs must, the devil drives – any gaps in supply will offer opportunities for the likes of Iran, and indeed their own production has increased dramatically since March.  I believe the worst-case effect will be to slow the rate at which inflation falls, rather than drive it higher again.

Finally, let me return to the short-term issue.  The fact that we report weekly, monthly or whatever about market movements is because we must demonstrate diligence, prudence and measures of reassurance where necessary.  It is also an opportunity to promote education and comfort through better understanding of market behaviour. However, we tend not to make decisions based on new data, but on the whole dataset (ie with the new data added). 

Warren Buffet once opined that “in the short run, the market is a voting machine but in the long run, it’s a weighing machine.” The market can indeed behave like an election in the short term, determining asset prices based on how popular or unpopular they appear at the time. When markets behave like a voting machine, they tend to ignore an asset’s underlying fundamentals and are driven by speculation, sentiment, and ‘new news’.  This can create asset bubbles, drawing investors to mount the gravy train.

When fear takes over, it is not unusual to see some investors “throw the baby out with the bathwater,” as they rush for the exit. It might surprise you to learn that machine-led trading programs account for more than a third of UK equity volume and ~60% in the US.  Computer algorithms create buy and sell instructions based on defined criteria with little regard to company fundamentals, research, or valuations. Thus, these “non-thinking traders” can trigger self-reinforcing short-term selling loops, and unwitting investors are unduly influenced and may even panic accordingly.

In the long run, the market acts as a weighing machine. Asset prices eventually reflect their fundamental characteristics, eg equities mirror a company’s earnings growth potential, financial strength, competitive advantages, and management quality.  Bond values echo the credit worthiness of the issuer, the relative value of the income payments, and the bond’s maturity value.

While there are temporary disconnections, the weighing machine always wins out.

See you next month...


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