Author: Mark Sloss (page 1 of 6)

WCM Chart of the Week for October 18, 2019

Chinese officials announced year-on-year 6% GDP growth for the third quarter, which was slightly below consensus estimates of 6.1%. The main drag on the economy was slowing investment growth while factory output rose along with retail sales. Tightening credit conditions are also contributing to the moderation in growth as officials continue to address excesses in the financial system. The on again/off again US trade negotiations continue to be a source of uncertainty. The government’s target of 6-6.5% growth for 2020 is at odds with market forecasts. The International Monetary Fund (IMF) is expecting Chinese GDP to fall below 6% to 5.8% in 2020 and continue to moderate in subsequent years, slowing to 5.5% in 2024. In the near term, Chinese officials have ample fiscal and monetary flexibility to manage the economy. However, in the long run, the adverse impact of the one child policy will cause demographic trends to deteriorate rapidly. The National Bureau of Statistics previously announced that births dropped to 15.2 million in 2018, representing a 12% annual decline following a decline in 2017. Some see China’s population beginning to shrink as early as 2027 and others argue that it had already begun in 2018. A rapidly aging population will place strain on social services and likely constrain China’s fiscal flexibility in years to come.

WCM Chart of the Week for October 4, 2019

A 1.5 degree Celsius rise in global mean surface temperature over pre-1900 levels is considered to be a critical threshold above which environmental systems start to break down and serious and durable damage from climate change to the world around us really takes hold. 2 degrees is recognized as a tipping point where the damage is both catastrophic and irreversible, at least in terms of human timelines. This week’s chart is from the Intergovernmental Panel on Climate Change (IPCC) and shows us where we have been, and a possible range of temperature outcomes 80 years out, if we reduce anthropogenic (human-caused) CO2 emissions to zero over various time horizons. Even the best case projections, assuming aggressive and immediate emissions reductions, have us only leveling off around 1 degree over 1900, more or less where we find ourselves today. From a capital markets point of view this tells us two things – first, a best case means a continuation of much of what we have been experiencing with extreme climate events and therefore climate resiliency must be factored into risk assessments and securities pricing for equities, real estate, infrastructure, natural resources and bonds in the public and private sectors. Second, if we don’t turn the corner, the system will run away from us, mitigation will no longer be an option and asset prices will be jeopardized globally. Even being motivated solely by profit and loss this challenge is existential to the capital markets and must be addressed.

WCM Chart of the Week for September 27, 2019

On the last day of Climate Week, we shift our focus from where we started with bonds to conclude with global equities. One of the tired old tropes that gets trotted out for people who have not looked at the data is that ESG-oriented strategies are structurally disadvantaged and destined to underperform. Of course, every strategy follows its own course based on benchmarks, PM decisionmaking, trading effectiveness, and a variety of other factors. But if we take the discretionary elements out and just focus on index comparisons, we do not find any persistent lag or advantage. Yes, performance varies somewhat in the short term.

Sometimes ESG leads, sometimes it lags. Over market cycles though, these small variations sort themselves out and you end up in the same place. MSCI, one of the world’s preeminent index authorities, has maintained an ESG Leaders series of equity indices that start in 2007.  According to Bloomberg, since the inception of the global ESG Leaders Index (on September 28, 2007) through September 26, 2019, the ESG index total return is 72.4% compare to 71.3% for the global equity index, or annualized total returns of 4.64% and 4.59%, respectively. This week’s chart shows this relationship graphically and there do appear to be cycles of outperformance as well as underperformance of the ESG index.  However, this is considerably exaggerated by the scale of the chart as the differences measure in fractions of basis points.

The Purpose of a Corporation

It will take some time to unpack both the intent and the implications of the Business Roundtable’s redefinition of the purpose of a corporation, but a quick meditation on their announcement on August 19th leads to a very confusing place for a sustainability-minded stakeholder.

On the surface, the “Statement on the Purpose of a Corporation”, co-signed by 181 CEOs, seems like a tectonic shift in the alignment of stakeholder values. At long last, corporations are committing to prioritize something beyond unadulterated capitalism. The points they made and the rhetoric they used could have been taken right off the vision boards of a thousand responsible and sustainable investors. The five central principles they outlined are (direct quote from the Business Roundtable, August 19, 2019):

  • Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations. 
  • Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
  • Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions. 
  • Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
  • Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.

These principles actually vibrate on the same wavelength as the Certified B Corporation “Declaration of Interdependence”:

  • That we must be the change we seek in the world.
  • That all business ought to be conducted as if people and place mattered.
  • That, through their products, practices, and profits, businesses should aspire to do no harm and benefit all.
  • To do so requires that we act with the understanding that we are each dependent upon another and thus responsible for each other and future generations.

So where’s the fly swimming in the punchbowl? The sub-heading for the Roundtable’s press release said the following – “Updated Statement Moves Away from Shareholder Primacy, Includes Commitment to All Stakeholders”. Again, at face value this is a good thing putting aside profit and shareholder value as the priority above all others. But, this announcement lands almost contemporaneously with an announcement that the SEC would be holding meetings to discuss a plan on the table to reign in proxy advisory firms (a prior discussion of this move from Cydney Posner, Cooley LLP on the Harvard Law School Forum on Corporate Governance and Financial Regulation can be found here), and during a period where the SEC has been increasingly lining up with companies to brush back shareholder resolutions and keep them off the proxy ballots. This move to limit the shareholder franchise has taken the form of questioning the materiality of the resolution to the overall business, as well as inching toward requiring a minimum percentage of ownership in order to sponsor a resolution. 

The danger here is that the confluence of disenfranchising shareholders with this new announcement from the Business Roundtable could actually mean a net setback if sustainable business behavior is defined almost exclusively by what management says it is without the input from and the natural corrective of the shareholder. That fifth principle is the linchpin to whether this will work or not – being “…committed to transparency and effective engagement with shareholders.” If the SEC defangs the shareholder, what does that actually mean in practice? We have seen repeated examples from aerospace to pharmaceuticals where self-supervision and fast-track regulation lead to bad outcomes for all stakeholders.

The Roundtable is on the right track if these principles are pursued in a regulatory environment that preserves an appropriate level of governance and accountability for shareholders, who are ultimately the only ones that have the ability to hold managements fully responsible in a free market. Employees can quit, customers can boycott and suppliers can freeze their pipelines, but boards and C-suite executives work for the shareholders.

Only Nixon could go to China

The on again off again trade spat with China seems to be peaking this week. Tonight is when the new tariff regime is supposed to go into effect if the two sides do not come to a different accommodation. There is of course some question of whether President Trump (or Xi) will blink and business can continue as usual. If we learned anything from the government shutdown over the holidays, it is that DJT will not hesitate to do a Thelma & Louise and take us collectively over the cliff. In his bare-knuckles negotiating style, the other side has to believe there is no bridge too far to get what you want.

And, there is a very strong case that has been made over decades that China needs to bend. They have benefited from overly generous policy for decades now that allowed them to build their economy while Western markets used them as a cheap outsourcing factory. Part of the price paid was a systematic forfeiture of intellectual property and inability to truly participate in their market. The benefit was, in two words, cheap stuff. With low wages, few environmental controls, and a myriad of other reasonable and questionable policies and practices, we enjoyed a tremendous arbitrage between their ability to make and our ability to consume that gave us everything from full shelves at dollar stores to affordable smart phones and other consumer electronics.

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To Brexit or not to Brexit

That is the question. Whether ’tis nobler in the mind to suffer the slings and arrows of outraged citizens, or to take votes against a sea of troubles, and by opposing end them?

We have been watching this theatre of the absurd since the exit vote passed, with calumnies hurled back and forth, plans drafted and shredded, ministers appointed, ministers departed, political lines in the sand drawn and redrawn, and no actual progress on either following or revisiting the will of the people. Parliament is so feckless they cannot pass a vote to move in any direction, nor can they muster the support to remove the leadership and try something else. Fortunately for the markets, even with trouble looming on the horizon, the net of doing nothing is that the status quo remains. It appears March 29th will come and go without any action beyond resolving the intent to plan for a discussion about the plan. Monty Python could not have written it better.

What to do?

There is simply no way the UK is going to stumble toward Brexit without some form of roadmap in hand. There are too many unmanaged and ugly consequences otherwise, from re-establishing a hard border between Ireland and Northern Ireland to trading internationally, even across the Channel, with no trade accords. With various structural events between now and Summer including the EU parliamentary elections in late May, there are plenty of reasons and plenty of opportunities to do something, even if that something is to resolve to do nothing. It may be that staring into the abyss is enough to compel the UK and the EU to address the Queen’s subjects’ major concerns around immigration, home-rule, etc. through the parliamentary and rulemaking process and belay or even ultimately put aside an exit. It could also be that the UK finds a way to rescind Brexit through whatever constitutional means are at their disposal.

But what if they do stumble out the door with no plan or path? It would be ugly and intensely unpleasant for everyone and may re-open old geopolitical wounds, but the free markets will price the new reality and, as the Brits say, carry on. We have seen a threat to asset prices in the UK and EU and have been significantly underweight relative to our policy benchmarks, although not exclusively for those reasons. Europe appears to be sputtering, including in economic powerhouse Germany, which has given us ample reason to believe the near term opportunities for investors are in North America and Asia. If the UK gives Europe Her Majesty’s middle finger, that could unleash instability and a repricing as markets try to find a new equilibrium based on conditions that have not existed since before many market participants got their educations and first jobs.

What we can do right now is watch closely. A disorganized Brexit could send markets into a period of significant turbulence. An orderly and well structured Brexit, or even no Brexit at all, could potentially herald a new moment for stability and growth and a reason to consider reinvestment in the region.

A moment of gratitude

As we have stated in the past, we consider days like Dr. Martin Luther King, Jr. day to be opportunities to speak less and listen more. Dr. King helped us all to better understand the value to society and to every individual in justice, inclusivity, respectfulness, shared dignity, and equality. These are messages and ideals that should ring throughout the year and not just on a single day. These are messages and ideals that should inform how we live, how we govern, and how we conduct business.

Thank you to Dr. King, and to his compatriots and successors, for words and deeds by which to live and thrive.

Finding the floor

When the market is in free fall, the question we always ask before being willing to assume more risk is “What will put in the bottom?”  We have found through our years of analysis and portfolio decisionmaking that the bottom usually arrives when a significant gesture from outside the market changes the direction of sentiment. The severe market correction stemming from the financial crisis a decade ago effectively stopped in March of 2009 when Treasury Secretary Geithner gave form and substance to the ideas put forth in the Emergency Economic Stabilization Act of 2008 (the Troubled Asset Relief Program, TARP). Europe stopped bleeding in late July of 2012 when Mario Draghi, President of the European Central Bank, said in his comments to the Global Investment Conference in London “…the ECB is ready to do whatever it takes to preserve the Euro.”

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WCM Chart of the Week for Nov. 28, 2018

After several months of outflows and painful underperformance, estimated money flows into the Vanguard FTSE Emerging Market ETF (VWO) — a popular investment vehicle — are picking up. Since its near-term bottom on October 29th, this particular security has risen nearly 6% after having fallen to a level last seen in early 2017. It may be early days, but this could be an encouraging development because the MSCI All Country World Index has only risen about 1.7% over the same time frame. Expanding investor interest in emerging markets may mark a point where appetite for risk assets begins to rise, which would be a welcome sign given the past two months of turbulence in global capital markets. We are optimistic on the prospects for emerging markets, especially Asia, in the long run. However, there are still significant headwinds—the slowdown in Chinese economic growth, the potential for continued trade-related friction, the strong US dollar and rising interest rates. Any stabilization in these factors could be supportive for further gains in the world’s emerging equity markets.

Start today, and give for the long term

Today is Giving Tuesday. Numerous worthwhile charities are raising their hands and asking for our attention and our dollars in pursuit of their missions. The difficulty with a one-day campaign is that, while it may bring in new dollars from existing donor relationships, there is a low probability of establishing durable relationships with new donors. Whether the connection is spiritual or practical, driven by a single crisis or by a lifelong pursuit, connecting givers with worthy recipients is a process. Not only does a donor, whether organization or individual, need to find that alignment of purpose, that donor also needs to go through some degree of due diligence to see whether the receiving organization is a good steward of donated capital and creating meaningful and measurable impact with it over time.

Let today not just be a flash in the pan, but let it be the start of an ongoing process for kind and caring individuals, families, and institutions to discover and build long term relationships with impactful organizations creating positive change in the world. As part of that, donors should also consider solutions that help create a platform for purposeful giving that could last months, years or even generations. Consider donor advised funds (DAFs), private foundations, community trusts, and other solutions that make it possible to institutionalize giving, make larger financial commitments that can be disbursed systematically, and provide partners and resources to help identify and evaluate potential recipients.

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