A step in the right direction…
For future historians the 24th of February may well go down as one of the most pivotal days in the 21st Century. The horrific unprovoked invasion of Ukraine by Putin’s Russia has brought war to Europe on a scale not seen since World War 2. It has disrupted the established world order and woken us up to the dangers of authoritarianism. From the perspective of investors, it can be difficult to process the events that have unfolded, particularly as it is an event that we thought had been consigned to history. We do not yet know how things will play out; however, it has reminded us that the world is an unpredictable place and more must be done to wean our economies off oil and gas.
Markets are UNPREDICTABLE
If the last 2 years have taught us anything it is that pandemics and wars are not relics of history. It is remarkable that despite the scale of each event markets have taken them in their stride and are in fact up over two years. Now let us cast our minds that back to the relative calm of January 2020, if at the time we somehow foresaw what the next couple of years had in store for us, it is quite conceivable that most of us would have been worried that this was going to negatively impact our investments and we would likely consider moving to cash. Yet, we would be far worse off if we had done this. It is not only difficult to forecast events in advance it is also nigh on impossible to accurately predict how the markets will react to the unexpected.
In the short term, markets are prone to overreacting on big news events, typically by responding too optimistically on good news and too pessimistically on bad news. In calmer times markets are quite often priced as if this period of calm is permanent, just a cursory glance at the events over the last 20 years suggest that shock events happen regularly, and markets respond quickly when they occur.
Often you may hear commentators bemoaning the ‘uncertainty’ affecting markets. Nevertheless, this is an integral element of investing and is just another risk to contend with. The nature of investing is to put capital at risk on the expectation of getting rewarded for taking the risk. Just as without risk there is no reward the same goes in the absence of uncertainty. It should be acknowledged that at times when there is more ‘certainty’ markets often reach their highest point, at this point people often become more confident and see the stock market as a money making machine. However, when markets reach a peak, it is in fact when there is the most risk to capital loss. The more expensive the stock market becomes the riskier it is; the more it rises the further it has to fall.
Markets are efficient so the price of financial assets reflects all available information. The price of assets changes on the release of new information. What we observe in normal times is that markets react and move very fast to developments in the news cycle, as participants around the world process new information and the result of this analysis is then reflected in the share prices of companies that make up financial markets. Yet, when a major global event occurs the market can take far longer to process the information and assess how the event will impact markets over the medium to longer term. This explains why markets can become very volatile with share prices moving around dramatically as the market assesses the situation.
Market turbulence is unpleasant, and we often feel that we must do something in response. It is important to fight this urge and instead remain calm and do nothing. For example, we may feel like we should move our investments to the safety of cash, though, this would be a mistake. Time in the market is far better than trying to time the market. As timing the market requires us to get two very difficult decisions right: when to get out and when to get back in. During the financial crisis the biggest net outflows from funds coincided with the bottom of the market in March 2009, the worst possible moment to sell!
The events of this quarter are another reminder that there will be plenty more global crises to come. Rather than worrying about this, it is better to focus on what we can control and think long term. Nothing too good or too bad lasts indefinitely.
Shot in the arm for Environmental Social and Governance (ESG) investing
It was Vladimir Lenin that said, ‘there are decades where nothing happens; and there are weeks where decades happen’, this certainly rings true of last few weeks and could end up being the case with the impact the invasion will have on ESG investing. The trend for sustainable/ethical investing has been gathering momentum in recent years as we wake up to the dangers of climate change. Now with the war in Ukraine there is a sense that not only should we be weaning our economies off gas and oil for environmental reasons but also for ethical reasons. Increasingly governments and society are becoming more uncomfortable with buying commodities from authoritarian regimes with terrible human rights records. The invasion has meant that it has become far more difficult to continue turning a blind eye to regimes with values we find abhorrent.
We may now be moving to a world where our values and principles are far more important than investment returns. For society the question we will need to ask ourselves is how much are we prepared to pay in terms of lower economic growth, lower investment returns and higher price of goods for the comfort of knowing that our hard-earned money is not making its way into the hands of kleptocracies like the one in Russia? Only time will attest to the strength of our resolve.
Staying with the theme of ESG, on a more local level the voices arguing for businesses to move away from the traditional sole objective of maximising shareholder value are getting louder. They instead urge companies to meet multiple goals that balance what is good for shareholders, society, governments, suppliers, and employers while being true to their company’s brand values. Business does not exist in a vacuum and has an enormous influence on the environment. By having a narrow focus on maximising shareholder value untold damage to the environment has been done. Fortunately, mainstream businesses have been taking tentative steps toward incorporating the principles of ESG investing into their business practices, nonetheless, much of this has been for marketing purposes and can be described as ‘greenwashing’. Despite this characterisation it can still be seen as a step in the right direction and points to the direction of travel that issues surrounding ESG are taking.
James Bacon BSc (Hons), MSc, Chartered MCSI, APFS
Chartered Financial Planner, Wealth Manager