17 February 2021
By John Husselbee, Co-Fund Manager DMS Verbatim Portfolio Growth Funds
The US has dominated the start of 2021, with the explosive final days in office for the 45th President culminating in the Capitol riots, and then Joe Biden peacefully inaugurated as number 46. Donald Trump’s actions earned him the accolade of the first president in history to face the prospect of being impeached twice and while it will be interesting to watch any possible trial, these are hopefully the last vestiges of the non-stop noise around him that has dominated sentiment since 2016.
Market watchers are hoping Biden and his team can restore a sense of calmness and civility to US politics but their first hours in power showed a clear sense of urgency, with a flurry of executive orders undoing many actions from the previous administration. New presidents tend to enjoy a spell of strong market performance and, on the surface, there seems plenty of news to spark a Biden bounce. Beyond the end of Trump, we have the announcement of a $1.9 trillion fiscal stimulus package, the Federal Reserve’s ongoing willingness to support markets, the President’s multilateral trade agenda and plans for stepping up vaccine rollout. For us, however, this speaks to the key question about US equities for 2021 and beyond; stock markets hit record highs last year despite the ongoing Trump melodrama and a global pandemic, so how much further is there to go?
To provide context for those market records in 2020, much of the performance of US equities overall can be attributed to a handful of large-cap tech companies (those FAANGs – Facebook, Amazon, Apple, Netflix and Google/Alphabet) that are now a dominant part of the S&P 500. As we all know, a large part of their success has come from relative Covid resistance, particularly versus more traditional consumer names, with the pandemic accelerating the global movement towards living more of our lives online.
Online penetration levels have risen sharply in the last year and we would expect some of the consumption patterns of recent months to persist post-Covid due to the increase in online literacy, even if there is a reduction from recent highs. However, we continue to believe performance from many of these stocks has been outsized relative to the opportunity: tech indices were four times ahead of the S&P 500 in 2020 and if you focus on just the 10 most-traded names, the so-called FANG +, this huge gap more than doubles.
We believe much of this share price growth has been driven by herd-like retail investing: the US government implemented generous stimulus packages during lockdown, including $1,200 for all citizens, and with plenty of free time on people’s hands, there has been a sharp rise in retail trading in the market. As a result, we are cautious on this sector and it is clear institutional investors increasingly recognise this risk.
Given such a backdrop, the question for us as asset allocators is whether these companies pose a systemic risk to US equities overall or will individually come unstuck over time. Looking at broader points first, a Democratic government clearly poses increased risk of regulation and ligation against big tech, with handling of data, policing platforms and encouraging competition in all areas that may be targeted by policymakers.
To be clear, however, we are not making sweeping comments about all tech stocks being in dangerous bubble territory; we are in a very different situation to the TMT boom of the late 1990s as many of today’s giants have considerable earnings and look in good shape for further growth. Where we do have concerns is when it comes to the ‘priced to perfection’ levels of many such businesses.
We have talked about a growing dislocation between market hope and economic reality over recent months and this is starkest in this particular part of US equities. We continue to believe it takes a major leap of faith to buy into these stocks at current prices, trading on multiples built on several years of future earnings. Given the path of many tech companies, it is hard to argue against them potentially achieving these earnings, particularly if they cut back on research and development – but the key thing to understand is that a huge amount can happen in three or five years, particularly in the face of Covid-19. This means investors are blind buying these stocks and if we continue to see market leadership shift to a broader base, as vaccines give greater visibility for the future, there could be further selloffs of the kind seen in September.
For us, Tesla encapsulates many of the concerns around ‘tech’, with a meteoric share price rise of more than 700% in 2020, fuelled by an army of retail investors. With a market cap of more than $800 billion at the start of 2021 (moving on rapidly from the chart below, created in December), the company is simply irreconcilable with other auto makers. While it is clear that Tesla has an edge in electric vehicles, changing regulations mean competitors are entering this market at pace.
When we look back at this point, our question is whether Elon Musk becoming the world’s richest man and Tesla the largest company ever to join the S&P 500 in December 2020 are signals of a market reaching its top, at least for certain businesses if not tech as a whole.
Given this situation, how are we currently looking at the US in our Multi-Asset funds? Based on long-term concerns about expensive valuation, the region has remained an underweight position and we have continued to favour cheaper areas including Europe, Asia and emerging markets.
Looking ahead to the rest of 2021, if we examine the earnings expectations across sectors, ex-tech offers many opportunities and we would expect investors to look at these undervalued areas as economies continue to improve. We have already seen early evidence of this, with fund ownership of technology decreasing for example and financials increasing.
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.