Published December 16, 2022
We found this opinion piece from Merryn Somerset Webb to be interesting as we turn our attention to 2023 projections. Ms. Webb writes for the Financial Times, among many other publications. Her commentary below obviously refers much to her home country of the UK. But many, if not most, of her observations apply globally. Of course, our models are agnostic to economic trends such as those discussed here. Instead, we focus only on the price and volume trends in the market – up or down – and attempt to react accordingly.
Here are Ms. Webb’s thoughts:
“The Association of Investment Companies recently polled UK fund managers, asking them what sectors they expect to perform best over the next year and over the next five years. The top two answers over both time frames were energy (28% over 12 months) and information technology (21%). All the other sectors lagged far behind (11% said healthcare).
This pretty much sums up the divide in today’s market. There are those who think everything will soon be back to some approximation of the normal of the last 20-30 odd years — inflation and rates will fall, the various supply crunches will sort themselves out, governments will relax and the market will revert to valuing growth above all. These are the people whose first question to every equity strategist is “when do we start buying tech again?”
Then there are those who find this terrifyingly naïve, who believe that this year does not represent a blip, nor anything close to an ordinary business cycle. For them, the volatility in the stock markets is telling us the story of a huge structural change — one that is taking us back to a different kind of normal, one that might mean you need to forget everything you have learned about investing over the last 20 years.
Think about the world of the last few decades. It has been a time of falling and low inflation, of plentiful (and pliant) labor, cheap energy, easy access to capital, globalization and a gradual shift in the world’s wealth from tangible things (energy infrastructure, machines, factories, inventory and the like) to the intangible (patents, data, brand value, etc.). In 1975, notes Saxo Bank’s Steen Jakobsen, intangible assets made up around 17% of the world’s wealth; the rest was real stuff. By 2020, that number surged to 90%. The intervening period had been a perfect time to invest in technology companies.
Now look to today. All of these trends are changing. Globalization is firmly in reverse — countries are backing away from the cheap, easy supply chains that once characterized trade with China and are looking to move manufacturing home. Apple Inc. Chief Executive Officer Tim Cook tweeted earlier this week about the opening of a new chip plant in Arizona, making clear that he is “proud to become the site’s largest customer.”
It isn’t just manufacturing either, it’s mining too. Look to North Carolina and you will see that it is home to the first rise in US production capacity of lithium (needed for batteries for electric cars) in more than a decade. The UK has just approved its first new coal mine in 30 years — just as British Steel has said it will stop importing Russian coal. Green grandstanding is suddenly less important than actually having the energy we need, which is no longer cheap thanks to the end of Russian exports and our own failure to invest in fossil fuel production.
Labor is no longer remotely pliant. In the UK, a perfect wage-price cycle is getting underway — real wages are falling and everyone now understands that in a way they did not when inflation was 2%. So the strikes have begun. Rail, health care, postal service and university workers are all on the go. In the US, consumer price expectations came in at 5.9%, up from 5.4% in September, and the labor market is, as Economic Perspectives’ Peter Warburton puts it, “tight as a drum.” Expect wage growth all around.
When the tide goes out, you can see who has been swimming naked, or so Warren Buffett likes to say. He meant it to refer to the corporate world. But it works just as well for countries: A nasty mix of general geopolitical tension, pandemic policy and war has meant that the tide of globalization — of cheap Chinese manufacturing and cheap Russian energy — has gone out for us. And we have been found to be less dressed than we should be.
Our physical world is too small to deal with the demand created by the energy shortage and the supply crunch. We haven’t got enough willing workers, manufacturing capacity or energy assets. So now we have to build them. The next few decades won’t be about apps, brands and eyeballs. They will be (in fact, already are) about building energy assets, improving electricity grids and building new manufacturing capacity across the western world. Think capital expenditure boom and industrial super-cycle.
In this environment, knowing how to invest in companies dealing in intangibles in a low-inflation environment is useless. You need to know how to invest in tangibles (the “builders of supply” as consultancy TS Lombard call them) in a middling-inflation environment — and you need to know how to do that at reasonable valuations, given that the end of the low-interest-rate world is also the end of the world in which price doesn’t matter.
Last year, 75% of those surveyed by the AIC said they expected global stock markets to rise in 2022 (this may be why, on AJ Bell numbers, only 13% of UK active funds this year outperformed their passive equivalents). This year, only 56% expect the same for 2023 — a clear lack of consensus! Either way, it seems likely that the market leaders will be energy, resources and industrials.
Consider me on the side that says this is not a blip — the same side as Morris Chang, founder of Taiwan Semiconductor Manufacturing Company. As he said: “Globalization is almost dead and free trade is almost dead. A lot of people still wish they would come back, but I don’t think they will be back.” Forget everything you have learned about investing in the last 20 years.”
Investors looked to receive a new batch of inflation data as well as hear from the Federal Reserve this week, with anticipation that the Fed would hike short-term interest rates another +0.5%. Optimism that inflation has peaked and the Fed would strike a softer tone fueled a +1.4% bounce Monday. The Tuesday release of the monthly inflation data confirmed the sentiment that inflation is coming down. Stocks added another +0.7% on the news. However, the market had opened with much stronger gains, rising upwards of +3% before sellers drove indexes back down, a reflection of the caution around the Wednesday Fed action. The Fed delivered the +0.5% as promised. However, Chairman Powell’s continued tone of caution around the outlook and insistence on interest rates rising further to make sure inflation is sharply whittled down caused investors to back away from risk. Stocks slipped -0.6% after being higher ahead of the Fed statement. The European Central Bank followed suit Thursday, raising rates and sounding very firm in their attack on inflation. Adding to the sour mood was a very weak retail sales report showing that consumer spending had fallen in November, while the Philadelphia regional report found manufacturing activity contracting. All the negatives sent stocks lower by -2.5% to break the trading range that had held up over the past month. Stocks fell another -1.2% Friday as the optimism over softer inflation data was now firmly replaced by resignation that the Fed will keep rates higher for longer while economic data weakens. It is noteworthy that the bond market is no longer responding to the Fed’s insistent tone, with market rates having come down steadily over the past six weeks and holding well below the levels targeted by the Fed.
Stocks fell again this week with the S&P 500 (SPY) off -2.10% and overhead resistance at the 4000-4100 level having won out. The Nasdaq 100 (QQQ) tumbled -2.76%. Smallcap stocks (IWM) lost -1.93%.
Warm wishes and until next week.