Market Update from Jilly Mann
I will start this update by referencing the potential elephant in the room, Tesla Inc. This US stock has risen over 248% year to date and with its headline-grabbing performance it would be odd not to mention it. Interestingly Tesla is listed on the US NASDAQ exchange, but not the S&P 500. The NASDAQ being an index measuring the health of the technology sector, whilst the S&P 500 represents the 500 biggest stocks trading on the New York Stock Exchange and the NASDAQ.
With Tesla’s performance, one could assume that it has already made it into the US foremost S&P index, however, it hasn’t quite made it yet. Its imminent entry into the S&P 500 index though is significant. It would be easy to assume that Tesla is simply another technology bubble stock waiting to happen and we do think it will pull back a little from its present valuation, but we don’t expect the bubble to burst dramatically.
Tesla has to fulfil certain criteria to be allowed entry to the S&P 500 and with its quarterly results due on the 22nd July, all the signs are that they shall fulfil those financial criteria and enter the main index. Why this matters is because on the one hand it signals further credibility in the renewable energy sector, but on the other it demonstrates investor behaviour in a way that we haven’t seen for quite some time.
When a stock enters the S&P 500, it is automatically owned overnight by billions more people. Funds or investments which track the US stock market will all suddenly become Tesla owners and they all want to be invested before the index transition takes place to try to make an even greater gain than the kudos of hitting the main market will provide on its own.
So that all sounds quite positive and provides some level of underpin to the rally we have seen year to date. To provide some balance though, one must proceed with caution. At the height of the corona virus market falls in February/March this year, Tesla shares fell from $918 per share to $360 per share. They have stormed back since then, but that fall highlights the risk of this one share alone. With that fall in mind, Tesla Inc is also the most “shorted” stock in US Dollar history at the moment. By “shorted” I mean investment instruments placed that will make money if the Tesla stock falls, rather than traditional equity purchases which make money if the stock goes up. One recent report suggested that there is over $19 billion placed in the expectation of Tesla Inc stock falling.
It could fall through general market sentiment, a stock specific issue such as more accounting concerns for Elon Musk or simply because it doesn’t achieve its promotion to the S&P 500.
We have remained very cautious on the US market through this year to date and this threat of overvalued stocks has been the main reason for that. Some funds we were considering previously owned 12% of a stock like Tesla at the start of the year, now yes that may have worked well if they rode out the waves, but how comfortable would we feel investing in anything where the exposure to one stock was so great if we were reporting to you in that February/March period as the stock plummeted.
That is the balancing act we have to play, we have to balance off potential stock market gems against the risk of them not firing and affecting investor portfolios.
It may then seem a strange time to be rebuilding our allocation to the US, especially as Texas and many other US states are living in the continued depths of Covid 19, but the stock market has been dislocated from Covid news since the initial hit to Western stock markets in the Spring of 2020. Oddly, days where the news flow is awful have resulted in some of the most positive days for markets.
We have introduced an allocation to the US into portfolios via funds which are heavily weighted to healthcare, online retail and entertainment technology. We are taking care to avoid some of the hardest hit US sectors such as hotels, airlines and department stores which are down around 50% year to date. If we believe that the virus is going to be around for some time to come, then the threat of further Lockdowns remain and so perhaps the stocks which have now weathered that initial storm shall also be the ones to survive, and hopefully thrive, in the virus waves to come. Maybe the length of Lockdowns and the fear of how to cope with a Lockdown scenario will start to abate, but those trends which have proven successful are most likely to continue. The fund we have chosen has a small weighting to Tesla, but my lengthy introduction to the stock is to explain that the success or failure of any stock isn’t black or white, and this conclusion applies across some of the most highly valued technology stocks on the US market. We may not like them and we may have concerns for their long term valuations, but right now in the environment we are living in, some exposure has a place in portfolios, especially as we have seen the winners and losers from Covid round 1.
I must point out that we rebuild our US position aware of the potential economic threat which looms at the end of July. Donald Trump’s equivalent of the Furlough scheme will end abruptly on the 31st July if no further action is taken. With an economic recovery seemingly Trump’s only remaining weapon in his arsenal ahead of the US election, expectations abound of further US stimulus measures coming through which should provide a further boost to investment markets. With events such as they are in the US presently, it is hard to foresee a scenario whereby Trump allows the date to pass without stepping in to seemingly save the day yet again.
In addition, around two thirds of S&P 500 companies are due to report their company results over the next couple of weeks. Banks may well lead the way with less poor results, but the majority won’t look good. The market knows that however and so there may be some down days if something major is announced which isn’t expected, but if markets make it through the coming fortnight, added impetus may well ensue that would be positive for both growth stocks and some of the more value driven holdings such as banks, which are a core component of the Schroder Global Recovery fund. Any such Global Recovery uptick may well be short and sharp, but we need to be in it to benefit. Global Recovery may well fall into a similar category as Resources whereby we see an upturn and look to exit fairly swiftly if we don’t consider there to be a long term reason to remain invested.
We have also rebuilt a position in European equities. We had concerns after the initial stock market rally in March around European cohesion. Longer term those concerns have not gone away, Italian debt levels are certainly nothing to ignore, but we remain in a time where long term investment decisions aren’t necessarily going to reward investors in the weeks and months ahead. In Europe we have seen Germany take a much more aggressive approach to fiscal stimulus than previously. Bloomberg term Angela Merkel’s response, the German bazooka, as her fiscal package of €1.3 trillion dwarfed similar stimulus measures around the world. This was quite a U-Turn from a country that was previously challenging the European Central Bank’s initial response to the Covid crisis through the courts.
Not every European country can afford to step in with such huge fiscal packages to ward off the recessionary consequences of Covid 19, but one suspects that Germany know that the stability of the broader European Union rests on their shoulders, so if Germany can pull through relatively unscathed, the hope for the rest of the Eurozone remains intact, for now at least.
To continue a theme, Germany’s fiscal response throws its weight behind their Green environmental targets and technology. It is becoming impossible to ignore these themes when Governments use stimulus measures to champion them. We have monitored how this “bazooka” has been received in Europe and feel comfortable that in the near term, there is plenty of pent up growth to be released amongst the winners from this Virus. There is certainly vastly more growth potential in European stocks than US stocks across the remainder of 2020 and 2021 and I would anticipate that if the funds perform as we hope, we may increase our European exposure over the coming months.
To make these changes, we have reduced our UK equity allocation. On a pure valuation basis, the UK remains cheap, it remains significantly undervalued compared to other global markets and so the case for UK investment remains, but only in selective areas. The consensus has turned rather on the UK market in the last couple of weeks with expectations of earnings now more than 15% lower than its nearest global rivals. The recovery in 2021 could well be strong, but we feel that the US and Europe offer better growth potential in the coming weeks and months. We have retained some exposure to the UK through smaller companies and some of the large cap names, but we have trimmed back significantly across the general UK equity market.
We have taken the opportunity to trim back our Natural Resources allocation. The fund has done extremely well since we bought back into it earlier this year, the oil price has risen to over $43 per barrel from $23 per barrel and the gold price has risen from $1,470 per oz to over $1,800 per oz. There are some commentators who believe the gold price could reach $2,000 per oz, but that is some way higher than its peak after the Global Financial Crisis, so is perhaps unrealistic. Oil commentators suggest $50 – $55 per barrel could be a sustainable peak for now and so all things considered, we aren’t too far away from either of those projections. We have maintained a healthy weighting to Resources as we think there is still some scope for the sector, but it seemed sensible to take some profits and start to trim our weightings. Experience of owning the sector shows that once the rally is over, it can turn just as quickly the other way and so we can’t become complacent when owning resources stocks.
It isn’t just about gold or oil though, Chinese consumption of Copper has pushed the Copper price up since mid-March, with the metal price rising 37% thus far. We are aware China is a controversial investment region, but they have managed their economy well thus far. There will always be mini wobbles at times, the current one stems from a sudden flow of money into the stock market from investors who had previously been coy on the area, but we think the trend for the coming months looks strong, based on technology, domestic China exposure and industrialisation measures driven by Government which result in the recent Copper price rises, as but one example. The combination of the Baillie Gifford China fund with the more restrained First State Greater China fund has worked well for us thus far and if one were to map the hit to global earnings which Emerging Market stocks as a whole have suffered in 2020 versus their growth potential for 2021, the downside is much less than Developed markets, with the upside being much greater as well.
We have made some minor adjustments to our property and fixed income allocations with portfolio liquidity in mind, as well as introducing a proxy should the US Dollar weaken, which is our expectation at the moment. The portfolios are structured in such a way that the exposure we have to the US Dollar should allow us to benefit if it weakens and not be exposed to too much currency risk.
Throughout the portfolios we have maintained exposure to healthcare as a theme. Central Governments are placing mass orders for trial drugs in the hope that the positive signs seen from the trials to date continues and they can be first in the queue for administering the vaccines once authorised. There appear to be two front runners globally in producing this vaccine and they are progressing through the trial stages, but pinning all hopes on these vaccines would be to put the cart before the horse. We have to assume that the present Covid world we live in will continue in much the same way for the foreseeable future, but if we do hear positive news on a vaccine, that will only be positive for healthcare stocks, alongside the optimism in the sector which could arise as Central Governments form plans to improve their management of future pandemic events.
In summary, we continue to take a much shorter term view on investment markets and allocations than we ordinarily would do. Overall, we remain confident that we have a few more months of recovery ahead of us, but the next couple of weeks might throw up the odd challenge to sit tight through. As ever, if something happens which changes any of these expectations, we will change course and protect portfolios whenever we need to.
In terms of Lockdown, in our Kettering office we aren’t too far away from the Leicester area and more local reports to ourselves are suggestive of relatively high Covid rates. We have remained thankfully unaffected thus far from the Virus itself, even as we have all returned to the office full time through July, but we remain vigilant to it and are fully prepared to revert to working from home should a localised Lockdown come our way, whilst continuing with the service and market updates we have provided throughout. Perhaps, on reflection, that is not the most positive note to end on, but nonetheless, with our clients spread far and wide, we want to reassure you that we are all set for every eventuality and remain available for any queries or concerns you may have.