Sidekick Money · Market Pulse: Economies Out of Sync, The Misconceptions Around ESG and Chaos Theory

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Welcome to this week’s Market Pulse, your 5 minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.

In this week’s edition we have:

Economies Out of Sync
The Misconceptions Around ESG
Chaos Theory & The Science of Fear

Adrian (Portfolio Manager), and the rest of the Sidekick team.

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It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

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1) Economies Out of Sync

In response to Wednesday's surprise inflation numbers, the Bank of England promptly raised interest rates by 0.5%. During the previous week, in just one day, the three most significant economic blocs – Europe, the U.S., and China – each made individual policy decisions. Like the U.K., Europe raised borrowing costs while the U.S. made no changes. China on the other hand, decided to lower them.

For investors, these contrasting moves are making the global economy harder and harder to figure out, not least because, in the last five years, central banks have moved in unison [1] [2], resulting in a similar macro backdrop. However, the divergence goes beyond monetary policy. It shows that the global economy, long benefitting from the momentum of globalization, is now a collection of very different cycles requiring different approaches.

The new landscape is more complex, yet the resulting uncertainty brings about investment opportunities in companies that are well-positioned or strategically adapting to these changing business conditions. For instance, while numerous companies boast about their pricing power during prosperous periods, it is during challenging times when the reality is revealed through their profit margins [3]. Similarly, it is amidst uncertainty - when companies or consumers restrain their spending - when we can clearly distinguish between "structural growth" companies and "cyclical" ones. And when it comes to innovation, it is during volatile periods when we are most likely to reap the benefits as customers and shareholders [4].

Investing may be challenging as we navigate this new landscape of contrasting global economies. However, a return to focusing on fundamentals can turn this into a stimulating search for hidden truths.

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2) The Misconceptions Around ESG

ESG’s loudest critic [5] had another swipe [6] at the Environmental, Social and Governance framework last week. Despite Tesla’s return to the S&P500 ESG Index, a sustainable investing-focused market gauge [7], according to some rating providers, the EV maker still has a lower ESG score [8] than companies like British American Tobacco [9] or Philip Morris [10]. How can a tobacco company be more sustainable than one that started an electric vehicle revolution?

The short answer is that it’s not. ESG became a synonym with sustainability because investors widely adopt the framework, but what gets lost in the flashy headlines is that the measure is usually not defined in absolute terms (altough some are [11]) but in industry relative ones. Therefore, a simple ESG score comparison between an automaker and a tobacco or an oil company tells us little about their differences in sustainability. A high score means that within the peer group, the company does better on different environmental, social and governance metrics.

Because the term “sustainable” is easily bent, EU regulators have developed a system to define sustainability clearly [12]. According to their definition, an activity should significantly help at least one of six environmental goals without harming others. These goals are climate change, clean water, circular economy, preventing pollution, and protecting biodiversity and ecosystems [13].

With the manufacturing of batteries and low-carbon transport as two key activities contributing to those goals, Tesla would have more than 90% of turnover in environmentally sustainable, taxonomy-aligned activities according to the EU’s taxonomy calculator [14]. This should put to rest fears that Tesla is not a sustainable company. Will its CEO protest about the remaining 10%?

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3) Chaos Theory and The Science of Fear

We discussed the optimism bias reflected in the VIX Index in a previous Market Pulse [15]. As the VIX continues to move lower, what baffles us is that despite the current long list of investor worries, the equity market remains exceptionally calm, even upbeat. Are we sleepwalking into a storm, or is Wall Street's fear gauge broken?

The pushback against the broken VIX is that despite the low levels today (around 13.2 as we write this), we are far from the lows seen in 2017-18 when it tested 9.14 [16]. Others blame traders' increasing reliance on short-term options for tactical trades and institutional investors' high levels of cash in portfolios requiring fewer options to hedge, thus making the VIX less relevant [17].

One way to make sense of high uncertainty and low market volatility is by examining the nature of fear itself. Interestingly, how we behave when afraid shares striking similarities with chaos theory [18].

Imagine walking alone on a dark road at night, worried about your safety. Suddenly, you hear footsteps approaching from behind. Despite growing fear, you keep walking… until something pushes your anxiety to a breaking point, and you must decide whether to confront the challenge or run away.

Chaos theory helps us understand these kinds of decisions. Merely experiencing more fear or uncertainty doesn't automatically lead to a change in our actions [19]. It's only when a specific event or catalyst occurs that we react. Similarly, the fact that the primary market gauge for fear is low shouldn't reassure us that everything is fine. Plenty of anxieties exist under the surface, and we are on the lookout for potential catalysts.

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Disclaimers

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Please remember, investing should be viewed as longer term. When we launch, your capital will be at risk — the value of investments can go up and down, and you may get back less than you put in.

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