15 April 2021
By John Husselbee, Co-Fund Manager WS Verbatim Portfolio Growth Funds
We wrote in our 2021 outlook that this year would see the end of three market-shaping forces and two of these have already passed into the history books in the first quarter, albeit with ramifications that will only become clear in the months and years ahead. A Brexit deal finally happened on Christmas Eve and Donald Trump has left the White House, giving way to President Joe Biden and the first unified government across the US executive and legislative branches since the mid-2000s.
That third force we hope to see eliminated is Covid-19 and, despite great progress on vaccine distribution in the UK and a path out of lockdown, this remains the ultimate unknown. Europe's rollout has struggled and the world clearly needs to brace for tough economic times ahead, with unemployment much higher than furlough-obscured figures suggest.
Another growing concern – albeit one with little evidence so far – is if post-lockdown activity sparks a stronger-than-expected resurgence and rising inflation forces central banks to move towards a rate-rising mindset earlier than expected. In the US, equities are around 15% above pre-pandemic levels and house prices are rising at the fastest pace in nearly a decade, pushing the household wealth-to-income ratio to all-time highs and providing support for consumer recovery. Against this, bubbles in certain – largely tech-related areas – continue to pose questions about potential fallout if the recent broad market rally reverses; investors are increasingly having to balance these concerns about higher inflation against central bank pledges of support, with bonds selling off aggressively over the quarter as a result.
In the face of this, markets were waiting to see whether central banks would blink, and Federal Reserve chair Jay Powell did everything he could to be at his reassuring best following the March meeting. Powell said there will likely be an inflation step up in March and April figures, but this one-time bulge will wear off quickly and not change the longer-term outlook. As a final positive, the Fed also announced an upward revision in growth forecasts for 2021 (to 6.5% from 4.2%), reflecting progress on vaccinations and fiscal policy, and markets were back up at record highs as a result.
In a busy March for central banks, the Bank of England's Monetary Policy Committee voted unanimously to keep interest rates at 0.1% and maintain quantitative easing at £895 billion. The Bank also expects inflation, currently at 0.7%, to move quickly back towards 2% in spring, due in part to recent increases in energy prices, but said there are no plans to tighten monetary policy until there is 'clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably'.
Over recent months, we asked if Elon Musk becoming the world's richest man might ultimately prove the top of the market for certain sectors, and – with hubris apparently working at breakneck speed these days – falls in Bitcoin over February saw him relinquish the title back to Amazon's Jeff Bezos. Beyond obvious and well-covered bubble areas such as Bitcoin and GameStop, however, there are other signs of froth emerging. These include record levels of venture capital funding flowing into markets and a huge spike in so-called special purpose acquisition companies (SPACs), created to merge with or acquire another business and take it public.
While markets are still far from risk off, we saw another sizeable correction in technology stocks over the quarter, although this sector and the market overall quickly returned to highs. We are confident in our long-term positioning, favouring ex-US and value equities, particularly if that twin spectre of inflation and higher rates puts technology valuations under further pressure over the months ahead.
Value has continued its rally post-November’s vaccine announcements, with funds such as Man GLG Japan CoreAlpha, JPM US Equity Income and Fidelity Special Situations among our top contributors in Q1. More growth-focused funds such as Lindsell Train UK Equity had a weaker quarter as that style lagged.
Japan had a particularly strong period, with the Nikkei breaching the 30,000 level for the first time in three decades in February as the country’s economic recovery from the pandemic continues. With a large proportion of export-driven businesses, Japan is well placed to benefit from a global economic rebound and structural reform is starting to pull the country out of its long slump.
Our emerging market exposure on the higher-risk funds was also positive in Q1 as the region performed well, with holdings such as Artemis Global Emerging Markets among the top contributors, although March was weaker on the back of rising inflation concerns and the associated fear of higher US interest rates.
Elsewhere, the worst quarter for many bond markets in two decades weighed on performance, as fixed income suffered a broad selloff over the period. UK gilts and US Treasuries were particularly affected as successful vaccine rollouts shifted the market narrative to focus on when policymakers may need to raise rates if better-than-expected growth leads to higher inflation. Against such a backdrop, several bond funds were among our weaker positions, with holdings including Axa Sterling Buy and Maintain Credit posting losses over the quarter.
Looking forward, we are increasingly comfortable adding UK equities to our favoured ‘cheap against the US’ collection of markets, particularly with Brexit finally in the rear-view mirror. With a pick-up in growth and economic activity expected this year, at least in certain areas, we have also increased exposure to small-cap equities as these companies tend to perform better during a rebound than larger peers. This is due, in part, to the fact they have a more domestic focus and will benefit more from increased consumer activity.
Our overall view of investment markets remains bullish, particularly for equities and high yield. A combination of government spending and corporate results largely justifies the recovery in equity markets over the past year and there is no obvious sign of tightening policy, with pent-up demand during lockdown still to be let loose on economies.
While there are potential hazards, from growth disappointments, through virus mutations and vaccine bottlenecks, to the mounting spectre of inflation, reasonable valuations outside of US mega caps means there are ongoing reasons to be optimistic.
Given Bitcoin’s recent surge, it is no surprise to see the cryptocurrency take technology’s crown as the most crowded trade in Bank of America’s latest monthly fund manager surveys. Continuing to highlight views moving towards our long-term thinking, the surveys also show a record number of investors moving into emerging markets and expecting the region to be the top performer in 2021, as well as the most positive stance on small caps versus larger companies on record.
We continue to remain underweight the US as there are cheaper opportunities elsewhere but if we examine earnings prospects across sectors, ex-tech offers recovery potential and we expect investors to look at these undervalued areas as economies improve. If tech does continue to sell off, we highlight the UK as an attractive option amid the reflation trade, with plenty of cyclical upside and structural overweights to sectors such as financials, energy and materials, which have been outperforming this year. Saying that, no one will be surprised to see figures released in March showing the UK economy back in reverse gear during January. While there was no mention of the Brexit effect in the GDP report, separate ONS data highlighted the largest monthly fall in goods imports and exports for the UK since records began in January 1997.
Looking to the next few months, consensus seems split between those urging investors to buy on the back of expected stimulus-fuelled recovery and others fearing an uneven vaccine rollout signals a fragile outlook amid stretched valuations. As ever, we warn against attempts at market timing and prefer to prepare than react, keeping faith that our long-term calls are increasingly bearing fruit.
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