Insights

Signal to Noise: what's material when investing

Paul Robertshawe

Investment markets are forward looking. Public markets that trade daily, like equities and fixed interest, absorb all new information today to try and instantly work out what that means for future interest rates, share prices, commodity prices and just about everything else that can be valued. Private markets like art, classic cars and watches move more slowly and there can be large gaps in pricing from one pricing event (usually but not always an auction) to the next. The concept of ‘price discovery’– knowing the value of an asset – is one of the major goals of a well-functioning public market.  To the casual observer, some of these moves seem quite dramatic for assets that are meant to be around forever, like a listed company. In fixed interest there are well telegraphed, long-term targets around inflation that should steer the market on what to expect. Deciding when to react to these moves is a key skill of active managers; can we separate the important signals from the distracting noise?

Looking back at 2023, we can see some large shifts in sentiment and consensus views, and their subsequent impacts on assets prices. The consensus is an average view, meaning there are always opinions counter to this. Holding those non-consensus (or contrarian) views, based on deep expertise and experience, is often the way active investment managers like Octagon add value to their client’s portfolios. 

At the start of 2023, there was a broad consensus that central banks had raised rates enough to slow demand and more than likely create a recession - an unfortunate but necessary step in bringing inflation back to long term targets. In March 2023 it appeared that this consensus was playing out in the mini-banking crisis triggered by the failure of Silicon Valley Bank in the US. Equity markets fell nearly 10% and interest rates fell even more (boosting the return on fixed interest assets). Swift action by global central banks restored faith in the banking sector.

Around the middle of 2023, a resilient US economy with falling inflation saw markets move towards pricing a more benign outcome - slowing inflation and growth, but avoiding a recession. Historically such a benign outcome is rare and both interest rates and equity markets responded positively.

Three months later the market began to question whether the world economy, driven by the US, was too strong and inflation might not fall as far or as fast as needed. Interest rates rose materially based on the expectation that inflation would stay higher for a longer period, and equity markets fell over 10%, as the equity market took the view higher rates must eventually slow consumer demand and cause company profits to fall. 

Fast forward another two months and data on inflation confirmed a downwards path; central banks noted that the hiking cycle was probably over, with the next move to be a rate cut, sometime in 2024. Both fixed interest and equity markets rapidly reflected this new “consensus”, delivering excellent investment returns from fixed interest and equities in the December quarter.

As active managers, Octagon Asset Management looks to formulate long term views on asset valuation – be that for an individual company or fixed interest investment or the overall value of a market. We then use short term market movements away from this long term view to decide whether to buy or sell an investment. But we don’t want to make decisions based on the noise. We only want to react to very strong signals, believing our investors benefit from long term exposure to attractive asset classes.

Over 2023, there was lots of noise relating to inflation and interest rates – I have only summarised the really large moves above – but in Octagon’s view, only two clear signals. So, for example, via Octagon’s investment committee processes, we sold fixed interest securities in March, when market prices reflected a very pessimistic outlook for the economy following the SVB bank failure and despite rapid response from central banks. Then, when interest rates peaked around October we added to our holdings on the view that long term inflation expectations were still accurate, and that these higher interest rates would be a temporary blip on the path to lower rates.

We are pleased with the performance delivered for both our Octagon Investment Funds and Summer KiwiSaver scheme members in what was a tumultuous 2023. We chose not to chase short term wins with the risk of poor outcomes, instead focusing on delivering growth for investors over the long-term.

Disclaimer: This article has been prepared in good faith based on information obtained from sources believed to be reliable and accurate. This article does not contain financial advice.