At the start of our Q2 review we highlighted the fact that, when assessing both current valuations and probable future direction of global asset markets, humans tend to have an almost unavoidable inclination to look at the recent past and extrapolate from that what they (we) think is likely to happen in the immediate future. Whilst the effect of recency bias on the decision-making process has been known for some time (the theory was first postulated by Hemann Ebbinghaus in the late 19th century), its influence on financial markets has undergone much study and debate in recent years and was probably most famously reviewed by Daniel Kahneman in his book “Thinking Fast and Slow” (2011).
Given the foregoing we wrote that the impact of recency bias was almost certainly causing investors to ignore “all evidence of the dark storm clouds gathering on the horizon”. Events over the last quarter have shown that our concerns were well justified as Q3 proved to be a particularly challenging period for global asset prices in general. Indeed, given the headwinds markets have faced and the causes behind those headwinds it is arguably surprising that the sell-off in financial assets has not been more pronounced.
We also highlighted in our Q2 report that there was clear evidence that whilst at the aggregate level equity markets (particularly in the US) have performed well, even a cursory examination of the reality underlying the “strength” in markets showed how narrowly based the returns were, principally focused on the new “miracle” stocks involved in the AI sector. A “market” rally predicated on a very narrow group of shares is usually, in our experience, a dangerous indicator.
With all investor focus seemingly lasered on to any stock vaguely associated with the AI sector, many commentators seem to have missed the fact that a previous “darling” of the market, the Clean Energy sector, saw share prices fall dramatically over Q3. In a sector “famous” for pursuing projects which tend to involve very high capex and very low cash generation and where, as a result, companies in the sector relied on either large government subsidies and/or cheap funding, it should come as no surprise that shares prices were be badly impacted by the sharp rise in both nominal and real rates of interest over the quarter.
The graph below shows the quarterly performance of the iShares Global Clean Energy ETF over Q3, which is down 23% from its high over the period.
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