What investors can learn from the volatility of the past

When the above charts started 30 years ago, the largest stocks in the Global Equity Index were the following (I show their current net debt/cash and return on invested capital – perhaps they were different 30 years ago, but unlikely to be very different, apart from GE, which had much more debt):

My conclusion is that the index used to be dominated by large cyclical companies with high debt levels and low returns on invested capital.

These companies gave investors a rough ride through the vagaries of the economic cycle, especially as their debt exaggerated the impact of the cycle. They also generally contributed to economic degradation and climate issues we face today.

By way of contrast, today’s equity index is dominated by technology companies with net cash on their balance sheets and very high returns on invested capital.

These seem likely to cope well with varying economic conditions, including rising inflation, which should have only a modest effect on their costs. The most likely risks to this group come from anti-trust regulation in the US and digital protection rules in Europe.

Cockroach stocks keep making money even in very demanding economic or inflationary conditions.

For those who can invest for the longer term, I would conclude that periods of market volatility throw up opportunities to buy global equities.

The largest companies in the indices (also the largest holdings in many funds) are fundamentally well equipped to grow shareholders’ wealth over time.  

Currently equity markets have been rocked by rising inflation and more recently by the Russian invasion of Ukraine. This has led to volatility and a sharp equity market correction.

The rise in inflation that was apparent at the end of 2021 made us look again at a range of companies that had been overlooked for some years; high-quality companies that grow less slowly.

We sometimes refer to these as our ‘cockroach’ stocks as they keep making money even in very demanding economic or inflationary conditions. 

This group includes US railway companies such as Union Pacific, telephone companies such as Nippon Telegraph & Telephone and Singapore Telecom. 

Wars, inflation, rising interest rates and even threats of recession make little difference to how much money these companies make for shareholders. We therefore feel they have a role in balancing an investment portfolio in these volatile times.

Medium term, the war increases inflationary pressures through restricting supplies of many commodities. The last time markets had commodity inflation and weak economies was the 1970s.

In that market a group of large, highly profitable growth companies dominated returns – they became known as the ‘nifty 50’. This was a small number of companies that performed well despite high valuations.