Transcript
Tom Merchant:
Hello and welcome to our Q3 investment update. My name’s Tom Merchant. I’m a partner and business development manager at Saltus, and I’m delighted to be joined by David Cook, our CIO. Afternoon, David.
David Cooke:
Good afternoon, Tom.
Tom Merchant:
Good. Over the next few minutes, so probably around 15, 20 minutes, we’ll be looking back at some of the key market developments from the third quarter. We’re going to be looking at what drove investment performance, potentially touching on what we feel like might be coming up in the future. As always with this, I do appreciate that there’s a number of you who listen to this who might have very different circumstances. If anything arises from this that you’d like further clarity on, or if there’s any questions related to your portfolios or maybe your tax arrangements, please do make sure you use this as an opportunity to reach out to your financial planner or investment manager, as obviously they are always delighted to hear from you. So I suppose without further ado, David, Q3, what happened?
David Cooke:
It was busy. It was very busy. Some big things happening. You might not have picked it up from the overall portfolio movements or equity market movements which were quite small over the three months between start and end, but there was a lot happening. I think the two most important things as categories are what was going on in bond markets because they really drove the market narrative, taking over from oil and the equity market earnings led momentum of the first two quarters. And then the second thing was new information on the artificial intelligence theme has been so important to growth and stock market performance, some warnings that future outcomes may not be benign. So if you talk about both those issues, maybe I’ll take them one by one. So, it could be quite a long answer to your question, Tom.
Tom Merchant:
That’s okay. So I mean bonds with the first one, that’s been a relatively quiet area of the market with AI and commodities, etcetera, taking most of the headlines. So, what maybe prompted them coming back to the forefront and how have they done so?
David Cooke:
Well, it was particularly in September, but throughout this year there’s been a general upward pressure in the level of bond yields, which means that interest rates are moving off long-term lows and climbing over higher. And a lot of the reasons for this are good surrounding the fact that growth in the world is pretty strong and there’s more competition for capital because of AI spending and the rest, but that’s generally pushing the cost of money or interest rates upwards. And then we have things like the oil price energy shock, which is adding to inflationary pressures. So what you’ve seen is a shift in expectation, which coming into 2026, people have thought maybe we’re in a world where interest rates are still falling or maybe going across. And now we’ve had to dramatically shift that opinion as we move through the year to expecting interest rate rises.
And we’ve actually seen interest rate rises during the quarter from the Americans, Europeans, and the Japanese. And a lot of this was the market getting ahead and kind of bouncing central banks into doing this. And actually by the end of September, things were looking quite nervous. We had the authorities trying to verbally intervene because the selloff in bonds was starting to look a little bit too quick. So there’s some verbal intervention and then policy was changed to catch up with the pressure that investors were implying through the bond market. And it’s just basically a recognition that that long, long, long period of declining interest rates, which is arguably since 1990 to 2020, it’s now well and truly at an end. COVID started it and the energy shocks added to it, but we’ve now found ourselves at the end of the quarter with bond yields higher than they’ve been for many decades.
So that’s a major shift. The regime has changed and now we have more of a headwind coming from interest rates than a tailwind.
Tom Merchant:
Fine, understood. And I suppose how has that played out in the portfolio? So is that being detractive from performance or how’s that manifested itself?
David Cooke:
We’d always thought that this was going to happen and going to happen for good reasons because the economy was growing and the AI investment train didn’t show any signs of slowing down. So the pressure was always going to be there. And what we though of it was it was going to happen, rates are going to have to go up, but this would have a moderating effect on economies and on stock markets rather than a dead stop. And that’s turned out to be the case. So I’d say that we managed to avoid the worst of this selloff because we weren’t exposed to very long duration bonds, i.e. Those that have a longer maturity to pay off. A lot of our exposure is very, very short and that’s less interest rate sensitive and that helped us, and also the equity market positions were quite reasonable. So we’re in a position now where there has been a selloff on bonds and we’re assessing it from the point of view to try to work out whether it’s an opportunity as opposed to dealing with the threat.
Tom Merchant:
Understood. And then conversely, if we’re taking traditional asset classes, then how have equity fed up against that with bonds taking a bit more of the headlines? How’s that look?
David Cooke:
Equities are done really, really well. You normally think that when the world, a big asset class like bonds is selling off so aggressively and money’s getting more expensive, equities would really struggle with this. But the thing that’s happened is that the profit growth has been so good, we’re able to absorb a higher level of interest rates. This is just for the growth that we’ve got on the world’s normal interest rates rather than restrictive ones. And I think that’s been a lot of the reason why equity markets have generally been so calm in between the start and the end of the three months. However, within equity markets, there’s been an awful lot of movement between sectors and there’s also some sentiment swings surrounding the AI story led by AI technology leaders and their statements.
Tom Merchant:
Fine. And I know that’s one of those, it’s a topic that strays into philosophy and all sorts of other, and maybe some sci-fi books, but also some realistic risks. So I suppose we can’t not touch on it, but that key person, forward thinker and innovator talking about those topics, specifically the anthropic CEO mentioning the existential crisis that if we use Gemini too much, it might end up ending all of humanity. How realistically does that move the market and is that something that’s going to be a small speed bump or how seriously is the market taking those threats?
David Cooke:
Because the AI trade has been so, so important to growth and driving super normal performance from the technology sector, which helps drive really good performance in the equity markets overall, it’s the most important thing. So when someone who’s as serious as Daria Modi, who’s generally highly regarded chief executive or anthropic, comes out ahead of initial public offering and saying the rate of improvement in the large language models is so rapid that very quickly we can find ourselves in a situation that if they went rogue or weren’t controlled properly, they could cause some serious damage to the internet or even in the physical world. So that theme gets, you’ve not told people who are backing up very dominant equity market theme that there’s a real risk of your product and service is going to cause harm. So you have to pause to reassess how to price all this.
And especially when bond markets are selling off as well, the net result is that the overall markets are going across once they digest this news and wait for data.
Tom Merchant:
I’m sure the sort of initial fat back to backers and the investment banks behind that was thrilled when that statement came out before
David Cooke:
This. Yes, trying to sell something which poses an existential threat to humanity. That’s quite a big risk.
Tom Merchant:
Yeah. I mean, as we discussed as well, depending how you feel about it, it is one of the key tenants of most people’s portfolios as commodity is typically oil. And we did obviously talk about, it’s not as short term as the CEO is suggesting in terms of the damage, but there is obviously a conversation in society around the existential crisis of utilising fossil fuels.
David Cooke:
Yeah, we have to note we live with existential crises all the time. There’s lots of asteroids floating around and there’s plenty of nuclear weapons as well. So though it sounds old, markets have experience of getting our heads around this risk. It’s also important to say that in the AI story that as well as going through the risks, this chief executive also outlined mitigation strategies to diminish or manage that risk, including using benign AI to monitor AI so we have a tool that lets us see inside the thinking and make sure that the products and services avoid the worst traps of misalignment. So there are plenty of mitigations to this and I think some of those are already in motion. But it was important to mention because we’re in a period of what the Americans would call show me. And I think in terms of what is AI going to do for us in terms of productivity and businesses and ordinary people’s lives.
And I think you’re seeing the early signs of something being shown, certainly in the corporate level. And I think the more we go through this and the more that we get our heads around the mitigations to the risks, the more stable the story will be after what has been and is a test at this point in time.
Tom Merchant:
Fine. And I suppose before we go too far down the rabbit hole that is this conversation around AI, should we go back to the more traditional means? We mentioned oil. So oil is obviously a huge driver early in the year and is obviously a keenly talked about things, especially if you filled up your tank recently. So let’s talk about oil prices and how that’s affecting the markets at present.
David Cooke:
Even though bond markets, government bond markets are meant to look through near term supply shocks like we have in the oil market, they often don’t, particularly in the UK where we’re quite energy sensitive. So gilt yields definitely have had an oil effect. And I suppose at this point of the year, we are well past the point at which we though this crisis would end. But then again, we also have extremely strong global economy and an oil price round about half where the divesters said it could get to. So clearly there’s been an offset to the risk from increased supply elsewhere and also through the straight of hormones. It’s acting to keep the oil price lower than it otherwise would’ve been. And then further down the product chain that obviously in things like diesel and petrol, they are experiencing much bigger price rises. So this is a real risk and the longer it goes on, the more it hurts, the more of a break it applies to economies that are pretty good at the moment and to markets which are going sideways.
So it’s definitely a risk. It’s just that the scale of the risk is smaller than we though at this point, even though the time it’s been in place is longer than we first thought. So we’re still in the mindset in the market that the oil supply risk situation is manageable and ultimately will be reversed.
Tom Merchant:
So previous quarter essentially there was a bit of a selloff on bonds, but we were positioned pretty well from it based on our short-term duration. Equities were sort of okay-ish, not too loud, and all prices are still slightly concerning. It’s in terms of long-term risk. So that’s sort of the backward looking story. Looking into the next quarter, I’m going to do the thing that you hate when I do this, what’s going to happen in three months and what dramatic changes have we made in the portfolios to affect it?
David Cooke:
What a great question, Tom. I think from the top down, it will be a period of moderation that we’ve been speaking about for a while as things get more complicated and financial conditions get slightly tighter. So just the acceleration phase and the super normal returns we had over the last three years, we had a good start to the year and now it’s just kind of tailing off a little bit. But that in our opinion is return to, let’s say more normal rates of return as opposed to a reversal and going backwards. And the major reason for this is that global economy remains very, very resilient and is undergoing something of a cyclical upswing and there’s also some inventory restocking going on. So it’s got legs and momentum and that can hide a multitude of sins. The other call that we have is that many of the pressures behind inflation should dissipate are temporary in nature.
Obviously a big one of that is oil discuss, but also those things like the tariff effects from 2025 are not going to influence as much as they did back then and nor are things like the exponential rises in some of the costs of software and computer other services that influence the inflation figure, particularly in America. Although prices might continue to go up, they’re just not going to go up as fast as they have been going up. And that means the rate of change of inflation is going to come off a little bit and that alleviates the pressure in the bond market, means that maybe interest rates don’t have to… It’ll be a very shallow or very modest tightening cycle and then we can stop. And that as a central case is what we’re still thinking. And those two powerful forces of interest rates peaking after a selloff, a modest cycle and the economy being able to grow through it globally is why we think the glass remains half full rather than half empty.
That’s just a central case, I have to say. I mean, there’s plenty of chances that it’ll not turn out as straightforward as that.
Tom Merchant:
Yeah, I appreciate that. I’m sure most of the clients will be aware that the reason you have a multi-asset portfolio in lots of different sectors is that’s always likely not to be carte blanche across the whole portfolio. Yes. I suppose we did touch on it briefly while we’re in the commodity space while it’ still front of mind, we did talk about the fact that we might be shifting a little bit in that space earlier. So should we touch on maybe that and the thoughts around the commodity market and what we might be doing within the portfolios?
David Cooke:
Yeah. What we’ve been looking for is in the higher risk investments, can we get something that gives you an equity-like return or better but just doesn’t move in tandem with the stock market? So it’s like having the same amount of risk, but better diversification. And outside of traditional commodities like precious metals of gold or copper or oil, we’ve had a small exposure we’ve made over the summer in carbon. Literally the cost of permits for emitting carbon around the world in America, Britain, Europe, New Zealand is rising and there’s a deficit of supply of these permits and there’s more and more demand. When demand’s greater than supply in a commodity, prices go up and they tend to go up independent of what’s happening in the FTSE 100 or the S&P 500. So that’s one thing. Another area is so-called transition metals or even things that relate to a new energy cycle like uranium, which is another potentially contrained supply and increasing demand.
And we add a little bit in that transition and uranium area through a manager for those portfolios that are able to cope with that level of risk. So we did do that. And the other thing I should say we’re looking at is obviously we have a budget in the UK coming up. We’ve had a sell off globally in bonds. We’re having a little thinking going, you know what? Is there enough value in UK government bonds to start buying the longer dated ones that we don’t have? So we don’t have any, but maybe at a good value now. And that’s a decision that we’re making throughout October.
Tom Merchant:
Interesting. Great. So I suppose from closing messages really, it’s sort of been a pretty good quarter, but as expected, we are glass half full going forward, but sort of conscious that there might be some pretty rational reasons why things might be slowing up a little bit in certain areas. But overall, there’s enough to be optimistic at least going into the last quarter of the year. But appreciate it’s incredibly short time to be holding you to anything like this. So if some of these things you talk about happened in January, we won’t hold you to it.
David Cooke:
Cautiously and sensibly optimistic. There aren’t enough reasons to say that we’re going into reverse. They’re not big enough and scary enough yet. They might be, but they’re not at the moment. So for the moment we think that’s half full rather than half empty.
Tom Merchant:
Perfect. Good. Well, listen, from my closing statement, David, as always, just thank you for your time and thank you for what the team continues to do. I’m sure our clients are very grateful when they see their quarterly statements, as have I, as one. So as before I mentioned, if anyone does have any further questions or they have anything concerning them or they want to just generally have a catch up, then please do reach out to your advisor or their team. We’re obviously always delighted to hear from you. And if you have any other questions regarding this content or anything else we’re putting out on the website, do please also drop us an email because we always love to hear from you. So I suppose for me, it’s just thank you for your time and David, thank you for yours.
David Cooke:
Pleasure. See you soon. See you. Bye-bye. Bye, Tom.
