Market Review

May was a positive month for global equities, with conflicting factors playing on market direction.

In the US, the House of Representatives passed a bill to lift the US debt ceiling and it is now expected to be approved in the Senate. The prospect of a US default had been a headwind to sentiment.

The potential of artificial intelligence drove interest in a small number of very large companies that are seen as likely to dominate the technology. One of those companies, chipmaker Nvidia (which does not qualify for our investable universe) announced exciting growth projections and its stock soared as a result.

The sheer size of these “tech titans” allowed them to lift a US equity market that was otherwise struggling.   Such has been the “narrowness” of leadership, that the largest ten stocks in the S&P 500 account for all the index’s returns so far this year.

Please note that none of the companies mentioned in this Market Review are part of our strategy’s investment universe as these companies do not provide goods and services that address sustainability challenges. This is the primary factor explaining our benchmark relative performance this year.

There were good reasons for negative sentiment outside these largest names.  The prospects for a global recession worsened as Chinese output slowed and measures of industrial confidence weakened.  The divergence between the services and manufacturing sectors widened: recent PMI (Purchasing Managers’ Index) data point to a contraction in manufacturing, while services are still expanding supported by robust labour markets.

That labour market tightness and sustained strong wage growth, along with stubbornly high recent inflation data have fuelled expectations of further interest rate rises from the US Central Bank.

Japan was the strongest performing major equity market over the month as investors were attracted by modest valuations and signs that the country’s persistent deflation may finally be coming to an end.  Japanese CPI (Consumer Purchasing Index) data came in at 4.1%, the biggest rise since 1981.

The UK was the poorest performer due to its high exposure to commodity markets, which weakened.  Oil ended the month down about 40% from the same time last year. Industrial metals were also weak as global demand faltered and commodity intensive activity in China slowed.

Technology and Communication Services were the best performing sectors while Energy and Materials were the weakest. The strength in the Technology sector helped growth styles to outperform.

Fund Review

The Fund delivered positive performance during the month, rising 0.9% which is broadly in line with the MSCI World, which rose 1.1%.

In a reversal to the previous month, Power Integrations and First Solar, along with Advanced Drainage Systems and ICON, were the best performing stocks over the month. Advanced Drainage Systems is a leading provider of stormwater management systems in the US. The company reported its full year 2023 results during the month, which were ahead of guidance.

Fisher & Paykel, Agilent, and Aptiv were the largest detractors of return. Fisher & Paykal’s results disappointed on the margins as did its FY24 outlook. Agilent reported strong 2Q23 results, but sentiment around biopharma has deteriorated and full-year guidance was lowered due to weaker instrument demand.

Resource Efficiency and Cleaner Energy were the strongest themes during the month and the largest contributors to performance, while Health and Environmental Services were the weakest.

Not holding some of the mega-cap tech/those stocks benefitting from Artificial Intelligence, along with the Fund’s mid-cap bias has been a headwind for performance in relative terms.

Outlook

Sentiment remains cautious. Recent economic data has been solid, and markets expect further interest rate increases.

Companies within the portfolio remain resilient in the current environment. While there is uncertainty in the short term, we remain confident in the long-term positioning of our holdings.

The merry month of AI

May seems to have been the unofficial artificial intelligence (AI) month.  Every day seemed to bring a new development, every conversation seemed to include it, every opinion-writer weighed in on it.  The noise built to a dramatic crescendo the day before the end of the month.  On 30 May, the newly formed “Center (sic) for AI Safety” (CAIS), published the most wonderfully punchy position statement I can remember:

“Mitigating the risk of extinction from AI should be a global priority alongside other societal-scale risks such as pandemics and nuclear war.”

Let’s park, for the moment, what climate change possibly still needs to prove before it makes that list.  Notwithstanding that oversight, the CAIS is an impressive organisation.  It’s not made up of lobbyists, politicians, or regulators: instead, these are the luminaries of the AI world itself, mostly engineers and creators who’ve devoted their lives to it.

There are plenty of other concerned voices too. And, on the other side, plenty of those that see the incredible potential, and are more sanguine about the risks.

These existential debates are now in full swing. So we should share the two key points we see right now about AI; how it impacts our strategy, and your investment.

The first, grander point is that we do lean to the more optimistic side. We kind-a have to.  Our strategy is to invest in companies that provide solutions to sustainability challenges.  In most cases, that is about technologies – tools, skills, know-how – and technical solutions. And AI is a doozy of a tool – it looks like it might be the best one yet invented.

Just how good is easy to see at ground level.  There are some incredible stories now, like Jan Oskam, a Dutch man who can walk again after ten years after being paralysed in a motorcycle crash.  AI is acting like a “thought decoder” to send the signals to his spine, that otherwise couldn’t get through.  Or, combining AI with spatial data to track and control fish stocks, apply fertiliser efficiently, reduce methane emissions, or manage pretty much anything else that moves.

The helicopter view is that AI will slice through the Gordian knots of sustainability.  We have previously talked about a VUCA world, a term we borrowed from the US military.  VUCA stands for volatile, uncertain, complex, and ambiguous.  It’s not clear if the world could ever not be volatile or uncertain.  But AI will certainly solve the complex and ambiguous.

The second way AI impacts the strategy is more prosaic.  One of the other reasons that May was unofficial AI month is that it left a pretty big print on global markets.

On 24 May Nvidia, maker of the kind of graphic-interface chips on which a lot of AI relies, issued quarterly guidance that beat analysts’ consensus by more than 50%. The stock rose 24%, taking it to over US$1trn in value, where it remains.

A host of other smaller companies which feed the AI value chain have had similarly positive experiences, both in fundamental outlook and share price. But it has boosted the “usual suspects” of the tech world too. Amazon, Alphabet, Microsoft, and Meta all have big plans for AI, and no-one (even governments) can match the money they will invest in it.

This has resulted in very “narrow” stock-market leadership. The largest ten names in the US S&P500 index have provided all of that index’s gains so far this year.

As we explained in our webinar for the second quarter of 2020, our overweight in technology stocks doesn’t include these mega-cap names. The technology they provide can be put to many purposes. We want to invest in the clever application of the core tech, to real-world sustainability challenges.

Those sustainability-focused AI companies are not here yet. Indeed they may not arrive in that form– it’s probable that those companies already experts in their fields, will more quickly learn how to adapt the tool to boost their productivity.

We are already seeing examples of this in our own portfolio. Contract research organization ICON Plc is using AI to predict the outcomes for patients in its trials. Water equipment company Xylem is using AI to predict infrastructure damage risks.  Spatialisation specialist Trimble uses AI to help minimise transportation accidents.

These are still early days though. As exciting as these initiatives are, it can still be frustrating as we watch the recent leaps forward in AI capability, and wait for it to translate into broader sustainability solutions. But we know that at the same time, the sustainability challenge is only intensifying.  As the sustainability pressure builds, the opportunity for those that can really harness this new potential will grow and grow.