In Focus

G.O.A.T

"I don't make the rules, ma'am. I just think them up and write them down." Eric Cartman

We have discussed many times the importance of individual freedoms in the growth process. As new inventions have landed in our midst down the ages, the rewards have often gathered to the societies able to bring at least some of the diverse might of their human capital to bear – the provision of civic space for the iconoclasts, misfits, and eccentrics is often seen as key to the success of the now developed world. Free speech, press, and other often uncomfortable inputs to (and outputs from) this individualism are seen as inseparable¹ from the past, present, and future of productivity growth.

As tech stocks make the headlines in the latest US corporate earnings season, could a look back in time provide useful context today for investors choosing funds, and voters electing politicians?

The ‘selfie’

The rise and rise of the ‘selfie’ is surely emblematic. The wonders of the world are now seemingly only wondrous as background for one’s own practised photo-gurn. Some² trace the origins of this strange artifact of modern tourism to a psychological schism in early medieval western Europe.

The Catholic Church and its increasingly entangled enforcers, the Carolingian dynasty, needed to break into a European society organised around family, the bonds of which were continually reinforced through intermarriage, polygamy, and other such practices. The Church’s answer came in the form of very specific prescriptions around the institution of marriage. Banned from marrying cousins (up to sixth) and funnelled towards monogamy, European families took on a very different shape to the rest of the world, with far-reaching consequences.³

Opportunities for independent decision-making, both male and female, multiplied as young families were forced to set up home far from the in-laws. This left gaps in areas such as care for the elderly, where impersonal institutions began to step in to help. Interestingly, this self-reinforcing cultural and institutional European path, distinct from the rest of the world, becomes more visible with the arrival of the movable type printing press.

In Europe, the arrival in the 15th century of the printing press sparked an information revolution. Literacy surged with book sales across the region. Public dissent, disagreement, and debate followed. The resulting reformation further weakened the Catholic Church’s grip on power.

Over time, rulers responded by falling into the arms of more commercial interests to prop up their leadership. In turn, those commercial interests demanded stiffer shackles on these same rulers as a price for their support, as well as the means of bloodlessly transferring power between rulers. So goes one version of events anyway.

And so to this week

The interplay of individual freedoms and institutions is very much the story of the moment for investors. We are in the foothills of another industrial revolution. The rewards to inclusivity are perhaps at the most economically tangible at such moments. However, there is of course risk in those same individual freedoms.

Very simply, there is no requirement for individuals to use those freedoms wisely, kindly, or even constructively. Whilst our capabilities collectively are unknowable from our current vantage point, we also know that we are beset by all manner of behavioural shortcomings.

Many of these can become dangerous when they show up in our leaders, from company to country, in the absence of restraints. We habitually overweight our own brilliance⁴ and agency in any success, often at the expense of the role of luck. Perhaps we also need this mostly misplaced belief in our leaders, part of a need to impose some order on the uncomfortable chaos we are daily surrounded with.

Investment conclusion

As we watch corporate earnings roll in and various (political) campaign trails heat up, there seems no shortage of charismatic individuals telling us they have the answers, whatever the questions. However, the familiar warning here for investors is to be wary of such claims. The story told above is one of restraints on executive power as a complement to individual freedoms.

Our rationality is bounded⁵ by all sorts of factors. This is why the way we select funds here focuses a good deal on the restraints surrounding even (particularly) the stariest of superstar fund manager. The dispassionate analysis of past performance, including an acknowledged role for luck, is central to the kind of funds and investments we deploy on your behalf. Similarly, the asset allocation framework we carefully plug these funds and mandates into is deliberately designed with those same principles in mind.

Likewise, it is why investors should focus less on the individuals vying for political office and more on the institutions that surround them. Elections are ever unpredictable and campaign trail promises rarely perfectly translated into policy anyway. The most important trick of liberal democracy is not grounded in a superior ability to pick leaders amongst the respective populations. It is instead about the ability to both move the bad leaders on briskly and to contain their worst instincts whilst they remain in office.

Article 1: Asian opportunities

In this short article, we summarise the insights of Will Hobbs (Will), Samson Olasoji (Samson), and Rob Mansell (Rob) as they reflect on the investor opportunities and challenges coming out of Asia.

Samson: Global economic warmth would appear to be spreading. The early warning indicators for the manufacturing and trade cycles are showing uneven signs of life (Figure 1).

Figure 1: Trade and manufacturing cycles turning

Source: Bloomberg, Barclays. Chart data from February 2022 to March 2024

Meanwhile, there is plenty going on in Asia even without the global cycle’s turn. From corporate governance reform to precarious property, I know this has been on your team’s radar for a while, Will. So, what gets you and the team most excited about Asia at the moment?

Will: An economist called Julian Simon controversially argued back in the 1980s that the most routinely underestimated resource on this planet is us – humans. At the heart of a series of rebuttals to the prominent Malthusians of the day was his revolutionary idea that "Resources come out of people's minds more than out of the ground or air.”⁶

Buttressed by reams of statistics (and outcomes⁷), he credibly flipped worries about overpopulation on their head. Given humankind’s innate creativity, our problem-solving capacity, the truth of economic growth is that the more of us there are, the better life gets.

The fact that well over half of the world’s population lives in Asia, a part of the world where educational attainment⁸ and wider opportunity are soaring, argues for strategic investors to be excited and invested almost come what may.

Samson: Nonetheless, investors in the region have to grapple with several major themes, from the slow-motion implosion of China’s real estate sector to varying demographic headwinds?

Will: Correct, this is certainly one of the areas where we feel our due diligence and research clout can really set us apart. Our best-thinking funds and portfolios have quite surgical exposure to the various parts of Asia, both emerging and developed.

There are, as you say, some huge forces, both positive and negative, to factor in for the investors we handpick on clients’ behalf. Chinese policymakers have an extremely delicate tightrope to walk, with lower trend growth surely at the end of it. However, the opportunities for careful, well-informed investors are still considerable.

Samson: Rob, you are part of the team that finds those best-in-class investors for us, and keeps them on their toes. Give us a sense of some of the views from on the ground as such.

Rob: Well, as Will says, in spite of some of the worries, there is still plenty for investors to get their teeth into in the region. Whether you look at the reforms gathering momentum in Japanese, Korean, or other such markets, or the continuing emergence of a truly massive consumer market, Asia should be impossible to ignore for diversified investors.

That said, this isn’t a blanket endorsement and we see considerable value in being active and selective. As an example, if you take the corporate governance reforms across the region, in many cases, there is good reason for scepticism.

There are considerable (corporate) cultural and other barriers to action, and progress can take years. In such cases, we feel that our clients really benefit from our ability to have investors in the region, holding management feet to the fire, assessing the likelihood and level of change relative to the market’s pricing.

With regards to China, I think we need to remember that whatever the narrative for the economy as a whole, there is a lot going on under the hood. If you just look at how far certain consumer goods have penetrated into households, from fridges to cars, you can see that there may be some way to go.

The Chinese market is significantly larger and more diverse than any other market in Asia outside of Japan, with thousands of listed companies for investors to choose from, spanning more than 60 industries. Again, this is a market where we feel we benefit from having experts on the ground.

Article 2: Europe’s moment?

The economic outlook is brightening noticeably for the Europe. Both lead and ‘hard’ indicators are showing important signs of life in the manufacturing sector (Figure 1).

Figure 1: Signs of life in Europe

Source: Barclays, Bloomberg, Factset. Chart data from April 2021 to March 2024.

Meanwhile, as this latest inflationary hump passes, we expect some swagger to return to the region’s consumers. Positive real income growth, allied to balance sheet strength and a central bank on target to begin cutting interest rates in the summer, should all help. Could it finally be time for the region’s equity markets to make up some lost ground? (Figure 2)

Figure 2: US stocks have trounced Europe

Source: Barclays, Factset. Chart data from December 2010 to December 2023.

The relevance of the (distant) past

There are many reasons for this relative shortfall. One important one has been persistent doubts about the life expectancy of the euro project. For much of the period since the great financial crisis, the region has been assailed by crises that would threaten to shatter it and inflict redenomination risk on would-be investors. To that extent, the weight of history has perhaps been underestimated throughout this period.

It would be a mistake to assume that the European project was dreamt up a couple of decades ago by some grey-faced bureaucrats. It can be plausibly argued that the unfinished union you see today can date its origins easily back to the 18th century. Then, as now, there were myriad motivations behind the uniting of a diverse group of cultures and languages.

Some of these early integrationist instincts can be seen as a response to a then revitalised Russia, unleashed by the reforms of Peter the Great. However, much can also be chalked up to attempts to build ‘perpetual peace’⁹ on a continent that was then ravaged by seemingly perpetual war. Interestingly, many contemporary texts and sources talk of the commercial benefits of such a union. But efforts to forge one struggled to gain traction.

As the 19th century aged, fresh impetus for union came from a somewhat surprising source – North America. By the end of the century, the rise of America was becoming increasingly impossible for Europeans to ignore. Its rise provided two kinds of stimulus for the Europeans: first, its booming economic clout and geopolitical swagger were of course seen as a threat, to which the logical response would be to pool European resources. However, America also provided a successful template for the benefits of the clubbing together of a diverse group of states. It was George Washington, in a letter to the (French) American revolutionary war hero Lafayette, who is thought to have first coined the phrase ‘United States of Europe’. That language did not become prominent in Europe until the middle of the 19th century, but it still illustrates that the idea is far from a new one.

Nonetheless, plans for union again stumbled. This time it was the mutual antipathy between the French and Germans that proved the major stumbling block, particularly over the contested region of Alsace Lorraine.It took the horrors of two world wars to apply the final push for Europe to start the process of integration in a more meaningful fashion. The treaties of Paris and Rome in the 1950s were the first real building blocks towards the incomplete union we see today.

Back to present day

There are many unfinished aspects to the European project as noted. One of the most important from an investment perspective is the Capital Markets Union. Fragmented capital markets in the region have resulted in a continuing reliance on overseas investors. As an example of the divide, a little over 10% of household wealth in Europe is unevenly in equities versus around a third in the US.¹⁰ So far reforms in this area have been slow moving, however progress is happening¹¹ all the same.

The politics of the region remain complicated of course, and a rash of regional and super regional elections in the coming quarters will no doubt provide plenty for the headline writers. However, there are positive developments here too, from the victory of centrist forces in Poland despite much reduced civic space, to a so far more-moderate-than-feared Italian approach.

Investment conclusion

Investment in European equities comes with baggage. The region’s stocks, like the underlying economy, are highly sensitive to the cyclical and other vagaries of global trade. War continues to rage on its Eastern edge. The political conversation moves slowly, sometimes imperceptibly. However, much of this is well-known and in the price as such.

However, in the context of that prolonged relative slumber, investors may be only slowly waking up to some of the more positive trends. Alongside a more helpful tailwind from the global manufacturing cycle, and the resilient underlying health of consumers, you are starting to see company bosses in the region buying back stock like rarely seen before. Could it be time for other investors to follow their lead?

Article 3: A long way to fall?

“Come on Cohaagen… give these people air” (Total Recall)

As US stock markets again loiter around all-time highs, it is hard to escape the sense that a juddering return to earth, wherever that may be, is a step closer.

The idea of putting one’s hard-earned money to work in an index (price or total return) that sits at all-time highs is surely counterintuitive, a perversion of the time-honoured advice to ‘buy low, sell high’? That is, of course, even more the case when the world around continues to appear so inconsistent with a buoyant stock market.

Where is earth?

That stock markets are often at the mercy of alternating cycles of extrapolative euphoria and pessimism is accurate. However, as we’ve noted many times before, timing these mood swings is easier said than done, whilst even not attempting to do so can be less costly than imagined. The fact that ‘the ground’ – represented by corporate profits for stock markets – tends to rise over time, provides a forgiving context for investors.

As the world economy grows, so too do corporate profits. The relationship between the two is not as precise as forecasters would like, but there is no fixed limit for either. The world economy is now 77% larger than it was at the end of 2007 (47% in per capita terms) and 24% bigger since the end of 2019 (18% in per capita terms).

That growth means a larger marketplace for the various companies that constitute the world’s stock market indices (Figure 1).

Figure 1: GDP, corporate profits, and stock prices

Source: Barclays, Factset. Chart data from March 1950 to March 2024.

In theory, in a growing economy, stock markets should be reaching all-time highs every day, because corporate profits will be too (Figure 2).

Figure 2: All time highs are common 

Source: Barclays, Factset. Chart data from October 2006 to April 2024.

What about valuations?

Not a week passes without one commentator or other telling us how dangerously expensive stocks are – the monetary experiments of the post-crisis era are perceived to have loosened gravity’s grip on equities, particularly in the US. There is much to say on this debate, but probably the most important point to reiterate for investors looking to the next 12 months, and even a little beyond, is that valuations are simply not a very good predictor of returns over this time frame. The last 12 months of stellar returns, amidst apparently asphyxiate valuations, pays ready testament to that fact.

It is also worth keeping in mind that we are always investing in a slightly different index as well. This perhaps also goes some way to illustrating the difficulties in looking to history for precise answers on valuation multiples – when does the comparison cease to be relevant due to changes in accounting standards, index composition, and wider economic context?

Valuation is, nonetheless, an important input into longer term returns. Today’s levels, although not as alarming as the caricature in our opinion, certainly suggest that we should temper our expectations for the next 10 years a little.

Investment conclusion

We do not yet see stock markets as disconnected from an increasingly vibrant economic reality. Neither do we yet see the signs of economic hubris or excess demand that herald the end of some economic cycles.

This suggests that the all-time highs recently rung in by various stock markets around the world are another staging post to be ignored. Corporate profits should continue to grow and so with them shareholder returns.

Analysts are no doubt expecting too much earnings growth – they usually do. Higher interest rates should crimp valuations a little too. However, even taking these into account, stock markets still look the best game in town for investors, both for the short and long term. Continue to invest accordingly.