Commentary on December 2020
Stock markets ended the year on a positive note, pushing higher into January, as investors continued to look through the horrific escalation in COVID-19 cases and focussed on the planned vaccine roll-out. Developed markets gained around 3% and Asian and emerging markets rose by over 6%, although a stronger pound reduced these numbers in sterling terms. Fixed interest bonds improved by around 1%.
The UK’s departure from the EU almost slipped under the radar but investors were relieved to learn that a deal of sorts had been cobbled together at the last minute. As further tiering and lockdowns were implemented, golden boy Rishi Sunak announced an extension of the furlough scheme and a series of business loan schemes which had been due to end in January.
Across the Atlantic the political farce continued with Trump refusing to accept the election result and encouraging an invasion of the Senate by his supporters, an action that subsequently led to his second impeachment. Meanwhile, the Democrats won both Senate seats in Georgia, giving them marginal control of the Senate. Investors concluded that this was OK as the tight margins, and party infighting, will prevent the more extreme policies from ever being approved. US Congress finally agreed to a USD 900bn economic fiscal relief package that will include direct payments to individuals as well as unemployment and small business aid.
The US Federal Reserve vowed to keep funnelling cash into financial markets until the recovery was secured, but reiterated that fiscal support was what was needed to help the real economy. Fed’ member Clarida went so far as to say, “we are not going to lift off until we get inflation at 2% for a year”. In the UK, members of the Bank of England’s Monetary Policy Committee continued to tease with talk of negative interest rates. The search for income saw bond yields fall further with Portugal the latest country to offer zero yields.
A major spike in COVID‑19 cases in the US and Europe is posing a renewed threat to the recovery, but if the vaccine rollout is successful we could expect to see a trough in economic activity in the first quarter before conditions rapidly improve in the second quarter. The problem is that stock-markets have arguably already priced in this assumption, leaving them vulnerable to bad news on the pandemic and any road bumps to economic recovery.
The US stock market is the most pronounced case of ‘over-bought’ shares, showing extreme valuation levels by any number of measures including forward earnings, as a ratio of US and global growth and against commodity prices; this has led to comparisons with the top of the dotcom bubble in 2000. Other markets have rallied strongly but don’t look as over-valued as the tech-heavy US indexes.
One metric that doesn’t show up equities as over-valued is the equity risk premium, the amount by which equity yields exceed government bond yields. Without getting into too much jargon, record low bond yields have supported share prices in general and driven the price of companies dependant on profits in the future (growth stocks) to extreme levels. If bond yields start to rise (see below) then this might cause a correction in stock-markets or, alternatively, it could prompt a rotation out of growth stocks in value stocks (those producing an income in the here and now) which would benefit the UK.
More recently, the US bond market has been shifting focus towards reflation, spurred on by talk of a further fiscal package once Joe Biden occupies the Oval Office. The yield on the US Government 10-year bond has doubled from its low of last summer to 1.1% at the time of writing. Investors anticipate a rise in inflation in the spring, caused by the oil price rebounding from its 2020 low of less than $20. However, consensus remains that there is too much slack in the economy to permit any real inflationary shock.
On balance, we feel that the recent acceleration in share prices leaves markets vulnerable to a set-back, but are less certain of the magnitude. However, with the outcome of the initial Brexit deal and U.S. elections now determined, and the availability of the vaccine expected to reduce uncertainty, we expect more companies to resume or grow dividends in 2021. Excluding worse case scenarios, lower prices are likely to attract buyers searching for income or simply betting on better times ahead.
How are we currently positioned?
We remain underweight fixed interest bonds and see little value at close to record low yields-90% of global government debt yields less than 1%.
In November we reduced our cash levels by increasing our exposure to both UK and global equities.
We are holding a mix of value and growth stocks but have sought to minimize exposure to US listed FANGS, where valuations have become excessive.
Our portfolios diversify risk by investing in a wide range of assets using actively managed funds with sound investment processes. Some examples of these ‘alternative’ assets are funds invested in gold & silver, infrastructure, agriculture and absolute return strategies.