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Five insights in five minutes

Five in Five: commodities, climate change, earnings, Nobel prize, AI
15 October 2021

    Commodity prices

    Your biggest client has just walked through the door. She slams a copy of the FT on the desk, leans in, and asks: “So where are commodity prices heading now then, eh?” One answer you could give is: “The same place your equities are going.” As can be seen in the chart below, the relationship between the S&P 500 and global commodities is pretty significant. Indeed, the current five-year correlation is about 90 per cent, based on Bloomberg data, the highest in 70-odd years. Versus global indices is similar. Also helpful is to remind your client of her dollar view. It would be inconsistent, based on a negative historic correlation of 60 per cent, to be bullish on the greenback and commodity prices. Between the two she has to choose. And now is not a bad moment to do so as both are up strongly year to date, affording the opportunity to take profits in one or the other. Such answers seem evasive. But a golden rule of portfolio management is to at least be internally consistent.

    Ways to play: commodities, US equities, global equities

    Commodity prices   For illustrative purpose only. 

    Climate change

    With the global economy closing down last year, carbon emissions fell by seven per cent. For context, that would put us on track to meet the goal of limiting global warming to 1.5 degrees Celsius – but of course it would need to happen every year for the next decade. Now emissions are exceeding 2019 levels again, and that’s before China’s decision this week to burn more coal to address an electricity shortage. Short of an annual pandemic therefore, solutions are needed to redesign economies. Innovation is the answer as well as an opportunity for investors. Already there is more than USD130 billion of assets under management globally in climate change funds, according to the IMF, more than double from 2019. Investor due-diligence is advised, however. The chart below highlights that funds with an environmental focus more often support climate-related board resolutions than conventional funds. A smaller difference lately could mean greenwashing by some. Invest wisely.

    Ways to play: Climate change equity funds, green bond funds

    Climate change   For illustrative purpose only.   

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    Earnings season

    This week marks the beginning of the US earnings season. How will company profitability compare with forecasts this quarter? Analysts reckon profits of companies in the S&P 500 should rise almost 40 per cent versus the previous quarter. That’s good, but not as impressive as it used to be, especially for financials, with consensus year-over-year growth estimates of ‘only’ 48 per cent this quarter – against 130 per cent in the second quarter. But remember that comparisons are confused by the fact that last year, earnings were bouncing off their pandemic floors. Still, the S&P 500 has already risen 18 per cent since January and the average stock in the index now trades at around 20 times forward earnings. Thanks to surging profitability, however, that’s down from 28 times a year ago and declining fast.

    Ways to play: US equities, global equities

    Earnings season  

    ESG in the Nobel

    ESG ideals are integrated in this year’s Nobel Prizes. The Physics award went to scientists that confirmed global warming (E); an economics gong to an academic who found favourable empirical results for a minimum wage (S); and finally the Peace prize was given to journalists whose life work has been to keep their respective governments in check (G). All three fields influence asset prices. But pay is a particularly hot subject right now, with equity investors pondering what happens when record profitability meets rising wages. In the US, and elsewhere, firms are simply passing higher labour and input costs onto customers – keeping returns elevated, as can be seen in the chart below. Indeed, with consumer price inflation running at more than five per cent these days, American real wages are actually declining! And what if inflation moderates, as we expect, but pay doesn’t? Then higher productivity growth is needed to maintain margins. A worthy topic for the next Nobel.

    Ways to play: ESG, global equities
    ESG in the Nobel    For illustrative purpose only. 

    AI in finance

    Whilst we wait for our commercial flying cars and personal robots, artificial intelligence is being implemented in the finance world as banks (such as us and see the UBS announcement this week) build AI teams to drive digitisation. Over half of global financial services professionals in a NVIDIA survey this year believe AI will improve revenues by more than a tenth, as shown in the below chart. Benefits to clients of asset managers can go even further. We all have behavioural quirks, so there is great potential for controlled AI to identify and minimise common investment biases, such as loss aversion (irrationally favouring the avoidance of loss more than an equivalent gain). Take a 2017 New York data based study from Economics Bureau for example, in which judge’s decisions made by AI rather than humans reduced pre-trial jailing rates by over 40 per cent with no increase in crime. Fewer biases should mean better investment decisions too.

    Ways to play: global equities and fixed income

    AI in finance   For illustrative purpose only. 


     


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