Market report - mixed messages

We are at another odd juncture for the world’s investment markets and the global economy they roughly represent. There are ways to make the various asset moves of the last few weeks marry up into a coherent narrative, but that narrative is likely fragile. A slide in commodity prices and the expected path of US interest rates surely speak of an anticipated hit to growth, a function of nervier banks in the wake of SVB, Signature, and Credit Suisse. The segment of US banks most affected by these jitters, likely resulting in lower appetite to lend (Figure 1), are also dominant players in US commercial real estate (CRE). Within this area, it is the office sector that is worrying many. A slow return to office work following the pandemic in many major city centres and the resulting reordering of corporate real estate, has already been pushing delinquencies higher. The swoon may now be a little more pronounced with funding likely clamming up further.

Those suspicious of a repeat of the Great Financial Crisis are surely finding some uncomfortable rhyme in all this. However, stock markets seem blissfully unaware, at least at the index level (Figure 2). The implication is that the potential nasties in office real estate and certain parts of the US banking sector can be contained without major spill-over. The idea being that the quoted equity sector benefits more in valuation terms from a slackened interest rate headwind, than it suffers from the expected hit to earnings.

That is certainly possible. However, we must also be aware that there are many ways that the short-term outlook can diverge from this fragile consensus. The threats are possibly easier (always) to imagine - the delinquency trends in office real estate could accelerate and metastasise into other sectors, undermining confidence more broadly. Inflation could continue to stubbornly defy central bank attempts to contain it, prompting yet more interest rate rises. At a minimum, the path back towards target level inflation is likely to continue to be jagged. It is also conceivable that the so far sleepier end of the depositor base could wake disruptively - the higher interest rates on offer in money market funds more noticeable in the context of the headline grabbing plight of many regional banks.

None of these threats are ignored altogether in market pricing of course. It is just that the probabilities implicitly assigned risk being too low. It is worth noting nonetheless, that the consensus is capable of being surprised positively too. Inflation could surprise us in either direction, perhaps we finally begin to see signs of sustained cooling of price pressures. This could conceivably play out amidst still resilient US growth - the Augean clear-out of the pandemic years, combined with a private sector larder still stocked with some of the massive support provided, could continue to smooth the transition back to a form of economic normality.

Meanwhile, there is much to be excited about for the medium term. The potential sustained productivity boost offered by ever more sophisticated AI, even if not quite of the general variety, may provide sufficient hook to keep investors engaged through darker times. None of the technological breakthroughs of the past have been unalloyed positives. The oft-cited printing press can be linked to decades of bloodshed and societal turmoil following its introduction. However, it can also be linked to the scientific revolution, urbanisation with all that entailed for productivity growth, the enlightenment, and beyond. The efficiency boost already promised by this latest rapidly evolving technology has the potential to reignite global (including UK) economic growth after a period of painful slumber.

The point as usual here is humility. Yes, there are opportunities for conviction in amongst the tumult of the moment. Our team of tactical investors continues to weigh up all sorts of interesting exposures to complement the package already in place. These are nonetheless small positions in the context of the overall multi-asset class funds and portfolios that we offer. Necessarily so. The idea of going all in or all out based on one particular view, positive or negative, of the future would gigantically overstate our ability to guess at what is coming. The future remains profoundly unknowable from our current vantage point. The act of getting and staying invested is an act of faith that humankind is not done inventing stuff and getting better at using it yet.

For what it's worth, we would be very wary of those visions that lean hard on a return to the familiar trends of before the pandemic. Perhaps the chaos of the moment makes our longing for the familiar even stronger. The idea that after all these various shocks to the system we will simply go back to the comfortable pre-pandemic trends, characterised by falling real interest rates and subdued productivity growth, may be well wide of the mark.

It is not just the breath-taking advances in Artificial Intelligence that are worth considering here (though these are likely central), it is the step-change in US investment and subsidy in clean energy technology among other areas and the likely response from Europe. We are potentially in a very different landscape for investment and productivity, which has the potential to catalyse a very different trend in real interest rates. That, in turn, could mean a very different leader/loser board both across and within asset classes than we’ve become used to.

Luckily that humility about the future is a foundational principle in how we organise our multi asset class funds and portfolios. We are always careful to keep a foot in the dustier, less fashionable corners of the world’s capital markets. The point is to plan for a multitude of potential paths ahead, some that look quite unlike the one already trodden.?

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