I think one of the most important disciplines in investing is the willingness to change your mind when the evidence changes.

Over the past year, investors have had no shortage of reasons to revisit their assumptions. 

We’ve experienced conflict in the Middle East, volatility in energy markets, persistent inflation concerns, rising long-term bond yields, questions around government debt, and an extraordinary wave of investment changes in artificial intelligence. Any one of these developments could have been enough to challenge an investment outlook. 

Yet despite the headlines, one conclusion has become increasingly clear. Many of the major developments of the past year have reinforced rather than challenged our central investment framework. 

That doesn’t mean portfolios have remained static. Nor does it mean markets have been uneventful. 

Rather, it reflects the reality that while facts have evolved, they have not changed enough to justify a fundamentally different course of action. 

A Lot Has Happened

There is a tendency in financial markets to assume that activity must always lead to change. In reality, some events alter the landscape entirely while others simply confirm existing trends.  Over the past year, we have seen several significant developments: 

• Conflict in the Middle East reminded investors that geopolitical risk remains a relevant consideration, particularly when energy markets are involved.

• Bond markets have become increasingly focused on inflation, government debt levels and the growing borrowing requirements of developed economies.

• Artificial intelligence has moved beyond a technology story and become a genuine economic and investment theme, driving unprecedented capital expenditure across large parts of the global economy.

• Meanwhile, central banks have continued navigating the difficult challenge of controlling inflation without unnecessarily damaging economic growth.

These developments matter. But importantly, most of them have reinforced themes we were already considering rather than introducing entirely new ones. 

The Bond Market Continues To Be The Market

While equity markets attract most of the headlines, the most important developments over the past year have arguably occurred elsewhere.

Bond yields have continued to move higher.

Long-dated government bond yields (10-30 Year timeframes) now sit materially above the levels investors became accustomed to during the decade following the Global Financial Crisis.

This matters because bond yields influence almost every other asset class. They affect borrowing costs, property valuations, infrastructure valuations, corporate funding costs and the discount rates applied to future earnings of investments. No doubt many of you have heard us bang on about this since the GFC, but its worth reminding everyone of it.

Higher yields help explain why asset markets have become increasingly selective. 

Not all companies, sectors and investments perform equally well in a world where the cost of capital (i.e. the interest rate you pay) is no longer free as it was after the GFC (zero to low % borrowing rates).

One of the defining features of today’s investment environment is that quality matters again.

Investors are placing greater emphasis back on business fundamentals, such as profitability, financial strength and the ability to generate reliable cash flows over time. Markets have become more selective, rewarding stronger businesses while exposing weaker ones. This aligns with the Investment Committee’s view that markets are increasingly being driven by fundamentals rather than broad market momentum.

In many ways, that is a healthier environment.

The Economy Has Slowed, But Hasn’t Stalled

A year ago, there was widespread debate around whether inflation would force economies into recession.

Today, while growth has certainly slowed, most major economies remain remarkably resilient.

Economic activity has moderated but has not collapsed. Labour markets have softened incrementally but remain relatively healthy. Inflation has eased from its peaks but has not entirely disappeared. Central banks remain cautious but increasingly appear to be managing a more orderly transition than many feared.

This remains broadly consistent with the soft-landing scenario discussed throughout our Investment Committee reviews.

For investors, a “soft landing” simply means that the economy slows to a more sustainable pace without experiencing the significant job losses, falling corporate profits and widespread disruption that typically accompany a recession.

That doesn’t mean conditions feel easy.

Many households continue to face pressure from higher living costs, elevated interest rates and affordability challenges. Businesses are also navigating higher financing costs and a more competitive operating environment.

However, despite those pressures, employment levels have generally remained historically healthy, consumers are still spending, and business investment has proven more resilient than many expected. Recent Australian data continues to suggest an economy that is slowing but not stopping.

The soft-landing outcome has therefore not been perfect, and there have been periods where recession risks appeared much higher. But as we sit here today, it remains a more accurate description of the economic environment than many of the more extreme forecasts that dominated headlines over the past few years.

Why Portfolio Refinement Matters

One of the most common misconceptions in investing is that successful portfolio management requires constant reinvention. In reality, investment success is often driven by the accumulation of smaller, well-considered decisions.

Over the past year, our Investment Committee has continued to assess and refine portfolio positioning.

We have reviewed the role of defensive assets, adjusted fixed income exposures, expanded and improved international equity diversifaction, increased allocations to productive assets and continually challenged our assumptions as conditions evolved. These decisions were not driven by a belief that the world had fundamentally changed. They were driven by our responsibility to improve portfolio construction within the environment we believed was most likely to emerge.

There is an important distinction between being active and being reactive. We strive to be the former, while avoiding the latter.

The Silent Alarms

Every market cycle contains risks worth monitoring. However, not every risk deserves a portfolio response.

Today, there are several areas we continue to watch closely.

The first is the gradual softening of labour market conditions, particularly in the United States. Employment remains relatively healthy, but labour markets often weaken slowly before they weaken quickly.

The second is the continued rise in long-term government bond yields. At some point, higher funding costs can become restrictive enough to influence economic activity and asset valuations more broadly.

The third is concentration risk within certain areas of equity markets, particularly those linked to the artificial intelligence investment boom.

None of these factors currently invalidate our broader outlook. But that doesn’t mean they are unimportant. It simply means they remain watchpoints rather than warning signals.

The Importance Of Discipline

Investment decisions are easiest when markets are either clearly improving or clearly deteriorating.

The more difficult periods are those in between. Periods where the news flow feels relentless. Where volatility appears and disappears. Where investors are tempted to react to every headline.

Today’s environment feels very much like one of those periods.

The challenge isn’t a lack of information. It’s determining which information genuinely matters.

For us, the most important question remains unchanged: Has the evidence changed enough to justify a different course of action?

At present, our answer is largely no.

Final Thoughts

Markets are rarely short of stories. Over the past year we have had plenty of them. Conflict, inflation, bond volatility, artificial intelligence, elections, debt concerns and shifting economic expectations have all influenced investor sentiment at various times.

Yet despite these developments, the broader investment landscape remains surprisingly familiar – growth has slowed but continues; inflation has moderated but remains relevant; interest rates remain higher than investors became accustomed to during the previous decade; markets remain selective; and productive, cash flow generating assets continue to offer attractive long-term characteristics for diversified portfolios.

At Falconers, we will continue to challenge our assumptions, monitor emerging risks and refine portfolios when the evidence warrants it.

But despite a year filled with headlines, our central framework remains largely intact.

The facts have evolved.

They simply haven’t changed as much as many investors might think.  

Cheers 

— Scott