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07/23
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w.AI.ting for Godot

By Andrzej Borkowski

In the Samuel Beckett play “Waiting for Godot”, the two main characters are expecting the mysterious Godot to arrive, and even though there are clues and indications of his imminent arrival, he never does. Godot in this regard is the recession expected by the market, that was already supposed to have happened by this stage in the year but has yet to appear.

For a longer-term investor arbitrarily selecting a block of one month or one quarter, or even half a year, to compare and analyse should not matter, but given we are about half the way through this year I wanted to reflect in general terms on some of things that have been going on so far in 2023. The two most obvious are the “Godot” recession that has yet to arrive and the A.I investment theme – both which I managed to squeeze into the title of this article.

So what clues has Godot sent to the markets and how are they interpreting these?

Markets began 2023 in a pessimistic fashion, initially expecting an imminent recession which would force Central Banks to come to the rescue by cutting interest rates by year end, but later all but pricing out any rate cuts in 2023 as inflation has remained high and we have had continued interest rate rises across most developed economies.

In the UK and the US for example interest rates are currently at levels not seen since before the 2008 Financial Crisis. So whilst the market has been expecting Godot, Central Banks have been continuing to raise interest rates, using the arguably blunt single tool at their disposal – interest rates – to try and manage inflation. I use the term blunt tool here, because in the traditional central bank model of the economy, inflation is the result of too much money creation by banks as they make new loans. As central banks put interest rates up, banks become more cautious about making loans, and so the economy tends to slow, and as a result inflation falls. We have indeed seen significant lending growth in recent years as interest rates have been very low, but other factors have been important too, notably government spending in response to Covid; supply chain problems coming out of the pandemic; and the sharp rise in commodity prices because of the war in Ukraine. Interest rates, of course, do not address inflation from these other sources.

 

Markets have been concerned about both the speed and the magnitude of interest rate hikes. While an obvious impact was felt by the regional US banking sector with the collapse of Silicon Valley Bank, other parts of the economy have yet to experience similar effects. During 2021, lots of companies took advantage of low interest rates to lock in lots of longer term debt at very cheap levels by historical standards, and so are not affected by the current higher interest rates. But over the next few years companies will need to refinance some of this debt at now much higher interest rates. Developed market Governments, by contrast, issued much more shorter term debt in the last few years, and are now having to refinance at higher interest rates.

So, for the time being in the US and UK for example, larger companies are not feeling the full effects of higher interest rates, the labour market is remaining resilient and there is still positive economic growth, albeit below longer term trend.

OR could the clues to Godot’s arrival simply be a time issue? Economist Milton Friedman famously wrote about the “long and variable lags” of monetary policy, and the current cohort of Central Bankers like to quote this. Perhaps it is the sheer size of the COVID stimulus, particularly in the US as the world’s largest economy, that is continuing to circulate, and therefore the usual impacts of large interest rate rises have been stretched out much more than anticipated. (the “long” part of that quote). In the US for example we are now only in month 16 since interest rates were first started to be increased, with historical averages of meaningful impacts of rising interest rates being anywhere from 13-24 months.

And so to the subtle typographical error in the title of the article, A.I. So far in 2023 we have had ChatGPT and all things Artificial Intelligence touted as the next “big thing”, with the potential of transformative growth and productivity gains arising from expectations around how AI will change the world. OR is it simply one more narrative to hold on to to delay Godot? Any CEO mentioning the two letters A & I during investor updates in the first half of the year was seemingly met with euphoric cheer, regardless of how tenuous the link. Looking at the performance of a handful of the largest US tech companies, the market has deemed these to be the largest short-term beneficiaries in all things AI, but my own opinion is that there is a long way to go in this story and so perhaps a heavy burden of expectation has now been placed on a small number, albeit large in value, of US tech companies.

Godot or not, what history does show is that stock markets, being forward looking in nature, tend to trough before recessions hit the real economy and likewise are already recovering and continuing to perform even while the real economy is still working through harder times. Therefore being invested in a diversified portfolio holding multiple asset classes is as important now as ever.

Andrzej

 

Risk Warning: Past performance is not a reliable indicator of future results. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.

Important Information: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. Past performance is not a reliable indicator of future performance.

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