Dear client,
Investors face an always-odd third quarter—given its nature as a holiday period in Europe and the US—having accumulated notable appreciations since the beginning of the year and considerably more since 2022 lows, a moment of maximum pessimism. This rebound has been very intense for stock markets, as illustrated in Graph 1.
Stocks or bonds: which is the right choice?
At the close of the semester, investors are split between optimists and pessimists, demonstrating the difficulty of anticipating short-term market trends. Investors are not alone, however: macroeconomists are also divided, with most predicting a recession in the US in Q4 2023/Q1 2024, though for the moment, the data does not support this hypothesis.
As history and experience dictate, when monetary policy tightens abruptly, a recession results. This is the view of bond markets and especially public debt, whose profile reflects what we call the inverted curve. The indication is that investors believe the official rates applied by the central banks to curb inflation will trigger a recession, forcing the central banks to change course. It’s a battle between Mr. Powell and Mr. Market!
Though these two perspectives are contradictory in the short term, time will likely prove one or the other—or both—correct. In the meantime, core inflation remains surprisingly resilient (Graph 2).
EDM portfolio and fund results
As Table 1 shows, EDM’s fund results for the first half of the year are very good, in both relative and absolute terms, allowing long-term investors to recoup much of the valuation declines in 2022 and, more importantly, contributing to the normalisation of long-term profitability (IRR/CAGR), the true objective of non-speculative investors.
These results reflect investors’ preference for growth/defensive companies over cyclical/value companies. To a large extent, it is the opposite of what occurred in 2022. Graph 3 clearly illustrates this trend, while Graph 4 shows how it is concentrated among a small handful of tech companies, which constitute the core of EDM’s portfolios and funds.
Looking ahead: the end of a long cycle
In this biannual newsletter, I want to share EDM’s vision of what we consider will be a long-term, monetary and geopolitical shift.
After a decade of fiscal and monetary stimulus (i.e.: cash injections of incalculable sums coupled with low/negative interest rates), we are entering a converse environment that will likely be equally as long.
The new monetary environment coincides with major structural economic changes and much more active industrial policies, if only to address the challenge of climate change. We need simply add geopolitical tension to the mix to understand that proper risk remuneration, after years of secondary consideration, will prevail in the world of investment.
And whoever says risk—assuming that this return to normalcy after years of sleepiness—implies selectivity, or concentrating on the best assets, will have the winning strategy and the necessary exactitude. A more in-depth examination of this topic can be found in Eusebio Díaz-Morera’s article.
Implications for management
This vision translates to your portfolio via three principles that we discussed in the latest Opinion Flash from May:
- DIVERSIFICATION: buoyed by the return of attractive defensive (IG) bonds, absent in recent years.
- QUALITY: concentrating on businesses with maximum foreseeability.
- DISCIPLINE: rigorous in terms of valuation, to reduce or sell positions that, though justified, imply that “everything must go according to plan”.
The application of these principles underlies the results of EDM’s funds and portfolios this semester, which far exceed their respective indices, climbing to the top of the rankings (see Table 1).
So... optimists or pessimists?
As a rule, investors are not pessimists. If they were, they would withdraw from both bond and equity markets, as frequently happened among short-term investors attempting to capitalise on this year’s rebound of positive volatility.
But it is important not to diverge from a strategy of investing in assets that protect against inflation, which is particularly relevant if we anticipate average inflation of 3-4% for the coming years. The cost of not hedging against inflation is considerable in the medium term, as illustrated in Graph 5.
Consequently, we are adapting our portfolios to this new environment, diversifying them into asset classes with greater or lesser volatility and alert to the opportunities that the market can offer, despite its inevitable cartwheels. For many of our clients, this means a return to the classic 60/40 equity-bond split after a period of greater equity exposure in the absence of alternatives.
I hope these words help instil some serenity at the outset of this difficult and incongruous summer season. I also hope you make the most of this time to enjoy a well-deserved break.
Many thanks again for your confidence.
María Díaz-Morera,
Chairperson
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