Stock markets have rebounded somewhat from the lows they reached in June. We continue to be at a turning point. As the global economy recovers from the pandemic, underinvestment in public and private infrastructure and disruptions and bottlenecks from the pandemic have led to a surge in inflation. Central banks, led by the US Federal Reserve, have tightened policy and raised interest rates in response. Will they lose control of inflation, get it right and adjust their policies in time, or will they overshoot?
Renowned economist Nouriel Roubini has just said it is delusional to think we can avoid a severe recession and a severe debt and financial crisis. The market has gone for boom and bust at the same time: it has sold off ‘growth’ stocks over ‘value’ stocks because of rising interest rates and stocks in general because of a fear of recession and collapse. We do not think we are delusional but we did say earlier this year that we were lunatics because we believe everything may be OK in the words of one of our favourite Matt cartoons. We cannot all be right.
The post-pandemic transition is difficult to predict and we have to be careful not to draw the wrong short-term conclusions. To us, company fundamentals matter most. We invest in companies that have quality and value for the long-term, and we look closely at what is happening to sales, earnings and cash flows of the companies we invest in.
Companies are reporting results for the second quarter and their outlook for the rest of the year. They matter because they offer the first real indication of how central bank policies are affecting consumer confidence. So far the results of our companies have been alright and we remain positive. We expect companies to signal that they are seeing a slowdown in demand but not a collapse; that consumer demand is slowing and that there is a shift from products to services; that corporate demand is holding up and that they are raising prices to offset increases in their costs; and that they are cautious in their outlook but will continue to innovate and invest in their businesses. A short-term sell-off may provide the opportunity to buy them at good prices but great companies create value from quarter to quarter. That is why we have to take a long-term perspective.
Currencies offer a lesson on that as well. It was almost exactly 20 years to the day when the US dollar/euro exchange rate reached parity this month for the first time since July 15, 2002. Currency exchange rates are driven by purchasing power parity and interest rate differentials. They have their ups and down but data shows that they do not matter over periods of three years or more unless there are specific events that make a difference. We invest in global leading companies because we think they are best placed to manage currency risks. They can align their sales, costs and balance sheets and they have the scale and knowledge to hedge their commodity and other exposures. It is one less thing to worry about for us.