Quarterly Commentary

12 October 2020

By John Husselbee, Co-Fund Manager DMS Verbatim Portfolio Growth Funds

Market review

When the news is dominated by headlines about the worst recession for 80 years, it is hard to fathom that global stock markets have rebounded over the past few months. This has been one of the starkest cases in history of divergence between economic reality and stock market hope.

With the former, we are facing global recession as country after country posts worst-ever GDP figures and the months ahead are likely to see heavy job losses as household names have to cut their cloth according to straitened conditions. In the UK, the economy suffered the biggest slump on record between April and June although GDP was positive in May, June and July. With August also expected to show growth, the country should exit recession this quarter, at least according to the technical definition, but there are growing concerns about a painful autumn and winter, with rising job losses, renewed restrictions in place on people meeting up and the Brexit situation once again falling into chaos.

Markets had a weaker month in September, with the US hit by a sharp selloff in technology names (of which, more later) and the UK by concerns over Brexit and whether harsher lockdown measures are to come. 

As for Brexit, whatever you might think about the individuals in question, to have every living former prime minister come out against a policy would give most people pause for thought at least; but as recent months have shown, Boris Johnson is not most people. In any case, he looks set to face weeks of criticism and internal revolt on the back of attempts to override part of the withdrawal agreement.

Johnson and team insist this capacity to break the law in a ‘specific and limited’ way is necessary in case of a no deal, which looks increasingly likely with the two sides in deadlock. But as this situation risks deteriorating into the melee of Theresa’s May’s time at the helm, the country appears to be losing patience as it wants the government to take better control of Covid-19.

On the policy front, we saw announcements from the US Federal Reserve and Bank of England in September, with the former sending out what it called ‘strong and powerful guidance’ that interest rates will remain near zero until at least the end of 2023. The central bank also said it would not tighten policy until inflation has been ‘moderately above’ above 2% for some time, confirming plans to run the economy hot until well into recovery from Covid-19. Meanwhile, the Bank of England remained dovish without actually doing much, keeping its powder dry for a difficult period ahead, particularly if the unemployment expected at the end of the furlough scheme in October turns structural.

Despite ongoing economic struggles, equity markets continue to close their ears to this distress and the S&P 500 has already roared back to all-time high territory. The fastest ‘bull market’ following on the heels of the fastest bear decline has clearly been positive for investors and seen paper losses (assuming people were not panicked into selling) wiped away. But beyond that, we question what it says about the ever-loosening connection between markets and fundamentals.

This increasingly bifurcated backdrop is a vital component of the impending generational election in the US, with the country engulfed in race riots once again, seemingly as divided as it has been for at least a century and Trump and Biden trading barbs. A poll from Politico revealed the genuine key topics among the American electorate, with the economy top at 76% of voters, Coronavirus third (after healthcare) with 73%, and relations with China bottom of the pile at just 42%.

Fund review

After the strong bounceback in the second quarter, Q3 was a slower, albeit still positive, period for most markets, driving a solid return for the funds.

The US remains the market where the dislocation between economic reality and equity hope is starkest and continues to post strong performance despite selloffs in some of the largest tech names in September. Our positions in funds such as UBS US Growth, JPM US Equity Income and Fidelity Index US were  among the strongest contributors over the quarter but our underweight exposure to a market we have long considered expensive remains a detractor.

Elsewhere, the UK remains among the weaker equity markets, weighed down by fears of a second wave of Coronavirus and fresh Brexit chaos, and holdings such as Fidelity Index UK and Fidelity Special Situations were among the detractors in Q3. The latter also suffered from weaker performance from value stocks, with growth characteristics reasserting themselves and much of the touted value recovery, particularly in the UK, confined to heavily Covid-impacted areas such as travel and leisure.

In terms of trades, we sold our position in Stewart Investors Global Emerging Market Leaders and recycled into the Legg Mason Martin Currie Global Emerging Markets Fund. Within any regions, we tend to hold a tracker fund plus value and growth options to provide balanced exposure. In EM, we have held the Stewart fund as our ‘growth’ option for many years but felt it was an opportune time to move to an out-and-out growth vehicle from Martin Currie, which currently has more than 30% in China.

Outlook

There remains huge uncertainty about Covid-19, in terms of further waves, vaccines and the long-term effect on people’s lives. More fundamentally, however, we feel the investment backdrop, at least in the short term, will be dominated by the growing division between economic reality and stock market hope.

Equities have always functioned as discounting mechanisms and looked beyond present conditions but the scale of the current dislocation calls into question exactly what markets are seeing differently. To a large extent, US technology performance has been behind this jettisoning of fundamentals and any debate on equity returns is about these stocks at present. The FAANG names have grown to such an extent that they effectively move the US market by themselves and there is a widening split between them and the rest.

For our part, we keep to the basic investment wisdom of buy low, sell high and have therefore been cautious on the US for some time, preferring cheaper markets such as Europe, Asia, emerging markets and Japan. There are arguments for and against tech continuing its run but we highlight several measures that show the US market as close to its most expensive ever, matching the Great Crash of 1929 and the top of the last internet bubble. It is also worth noting how few active managers, including tech specialists, are buying giant tech stocks at present, with passive investors filling the greater fool role.

For all the talk of fresh records for the S&P 500 in August, the US has effectively become a two-tier market, particularly post-Covid 19. Tech indices are around four times ahead of the S&P this year and if you focus on just the 10 most-traded stocks, the so-called FANG +, that already-huge gap more than doubles.

In our recent presentations, we have included a slide titled Tech and the beanstalk to remind investors what happened to the giant in the story, crashing to earth from a great height. Our caution on expensive US equities has only increased as market leadership has narrowed and recent sell-offs in these giant tech names, while limited, give an indication of how sharp a correction could ultimately be.

The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. The contents of this article should not be construed as advice and is for information only. Individual stock selection should only be performed by suitably qualified advisers.