Log inMarket Update 28th October from Jilly Mann
Market Update
As we wend our way towards the end of 2020, we may finally be inching closer to resolution on some of the key worries that have thwarted investment markets throughout this year. In this update we will cover the following key topics:
- US Presidential Election
- Brexit negotiations
- UK Equities
- Natural Resources
- Long Term vs Short Term Investment Decisions
- Covid 19
- China
- Sustainable Emerging Markets
US Presidential Election
The US Presidential Election is still no easier to call, despite it being now only a matter of days away. As usual, the televised debates have offered nothing constructive and despite Joe Biden’s apparent lead, it would still be brave to predict a verdict one way or the other ahead of the vote. For some time, there has been concern that the US markets will react in quite a fractured manner if Biden wins, but as the race has been so close, there is increasingly a feeling that markets may ride out the result, at least for the coming months, if not longer. That is perhaps a reflection of wider concerns surrounding the impact of Covid 19 on the economy and the reality that whilst some sectors such as the banks may offer some brief optimism, Covid 19 is driving everything at the moment and in a Covid world, technology stocks have been proven winners. Despite technology stocks suffering a relatively rough week on the stock market last week, the Baillie Gifford American fund remains up over 15% since we bought it in July this year. As we said at the time, it won’t provide a straight line upwards, but it does still feel like it provides access to the sector which is most relied upon in the world at present and the last few weeks have demonstrated that any falls are more than recouped in the following days. It is a trend we continue to monitor for all of the reasons we have stated previously and in the run up to the Presidential Election result, our eye remains firmly on reasons for or against the US stock market and technology continuing to rally against the broader economic backdrop.
Brexit negotiations
In Europe, it feels like the game of cat and mouse with Brexit might be edging towards a conclusive deal. Michel Barnier, the European Union’s Chief Negotiator over Brexit, did a further u-turn last week to recommence negotiations with the UK. This felt like yet another soundbite hint to the public that a deal will be done, albeit probably not until the last minute and not without each side defiantly standing their ground for the sake of not wanting to lose face. It feels like both sides have far more to gain from finalising a deal than they have to lose. Despite varying rates of infection spread across the continent, all sides know that a recession is not far away once this virus is under control, whenever that may be, so if they cannot yet control the uncontrollable virus, at least controlling a key trade agreement, with both sides pitching themselves as the victor to their people is not an unhelpful outcome for anyone.
UK Equities
On the basis that we think the markets will react positively to a Brexit agreement should one happen over the next few weeks, we have increased our allocation to UK equity, by including the Franklin UK Mid Cap and Unicorn UK Ethical Income funds in our portfolios. We have sold our exposure to the JPM Natural Resources fund in lieu of this.
Turning first to Natural Resources (a commodities focussed fund holding Oil, Gold & Other Metals), we have experienced a strong rally in this sector since we bought it heavily in mid-March, at the height of the First Wave of Covid 19. We marginally reduced our allocation a few weeks ago and feel now is the time to sell down. We must emphasise that we think this may be a short-term move as we are not yet convinced that the whole of the UK market will rally for a prolonged period, however, as we saw the Boris Bounce last October/November when the Brexit decision was finally reached, we feel that a similar market bounce may arrive if a deal is struck in the coming weeks.
At present our UK equity exposure is heavily weighted towards UK Smaller Companies, which have performed very well for us over the last six months and we expect them to continue to perform strongly in the event of a Brexit deal. One potential outcome from a Brexit deal for the UK could see Sterling strengthen. If this were to happen, it would likely benefit small to mid-cap companies more than large cap companies, because more large cap companies, such as those found in the FTSE 100, generate their revenue overseas. Thus, a strengthening pound may have a negative impact on their earnings potential. Small and mid-cap businesses typically have more of a domestic earnings base, which could see them benefit from a strengthening pound.
We would hazard that any bounce may not continue for long, because the threat of recession remains real in the UK economy. Once stamp duty property reliefs are removed at the end of March 2021, one could expect the UK housing market to slow drastically and depending upon the containment of Covid 19, there will come a point when austerity will come to town again. Quite what form that austerity takes and who will bear the brunt of it, will very much depend on the political game required at the time, but we have positioned the portfolios for a near term Brexit pick up, which we are anticipating needing to unwind later this year or early next year thus reducing our UK exposure again at that time. As ever, that strategy may change as the world changes, but looking back at the Boris bounce, the new funds we have selected performed strongly, returning around 18% each, during the period in question and we would expect a similar response this time around.
Natural Resources
Removing the Natural Resources fund may seem like a bold move, but the reality of the commodities market at the moment is that the catalyst for a significant increase in the oil price from here just doesn’t seem to exist and whilst the gold price remains high, it isn’t reacting strongly to market events at the moment. This may change rapidly again, but in the very near term we think there is greater upside potential in the overall UK market than there is in the UK commodities sector for the same downside risk, which is always one of our key criteria. If we think that the potential losses in both sectors are similar at any given time, yet the potential upside for one outweighs the other, that for us is a signal to switch investments. Once the Brexit decision is made or if global sentiment turns sharply downwards, we may revert quickly back to Natural Resources, so again we are not portending the end of our commodities exposure for good, we are just seeking to take advantage of a short-term tactical opportunity. Of course, if UK mid-cap stocks perform strongly for a concerted period, then we won’t just sell them for the sake of it.
Long Term vs Short Term Investment Decisions
I’m conscious that 2020 has seen us make a significant number of changes to investment portfolios as the year has developed. Our general approach to investment is to take a long term view, we aren’t setting out to time markets, we believe only hindsight has the power to know when was the “right” time to invest or disinvest, but as I have set out above, we are making more shorter-term tactical decisions in these markets than we ordinarily would do. We feel that we need to do so as the world is responding to this latest unprecedented set of events. I want to provide some context though to provide further reassurance, if it is needed, as to why this approach differs to simply buying a benchmark tracking investment. The image below represents the asset allocation for one of the benchmarks we compare against, the IMA Mixed 40-85% Shares index.
The colours represent different asset classes and the image shows how allocations to these assets have changed over the last three years, three years which have included Brexit negotiations, Donald Trump’s trade wars and of course, the Corona Virus. What struck me when I looked at this chart was how little the asset allocations have changed over what has been a quite momentous period. There is very little increase or decrease in exposure to any of these asset classes over the last three years, with UK equities represented by the top blue section (around 20.5%) and Asia Pacific equities representing the grey section towards the bottom (around 2.7%). In relatively benign markets, this laissez-faire approach may still generate more than adequate returns, but in uncertain market conditions, benchmark trackers are simply not designed to be nimble and make active decisions, whatever is happening in the world. A comparison between this index and our moderate risk strategy shows our moderate strategy outperforming this index by over 6% year to date as per the chart below.
We certainly aren’t resting on our laurels at this moment, as we can never guarantee what will happen tomorrow, but I thought the image and return differential aptly summed up why we are being so active at the moment and why you keep receiving updates such as these.
Covid 19
With regard to Covid 19 itself, mixed reports surround the availability of a vaccine with some reports over the weekend suggesting that the UK may be closing in on issuing a 2-stage vaccine to health workers before a roll out to the wider public. The validity of these reports remains untested, but as before, if a vaccine is found then one could anticipate a sharp uptick in stock market returns, before focus turns to the Chancellor feeling better able to commence austerity measures sooner, so there would be hugely positive news on a humanitarian level followed by cause for concern on an economic level. The good news is that global markets have trended sidewards in recent days as Covid worries have risen but haven’t yet reacted with the panic we experienced earlier in the year as the first wave of Covid took effect. If some semblance of order can be maintained, then again we would be hopeful that the overall trend remains upwards for now and some bad news days can be shrugged off relatively quickly.
China
On that note, I think China is worth a mention. I know the country (as the originator of the virus) divides opinion, but we have been invested strongly in the region since March 2020 and since then the First Sentier (formerly known as First State) Greater China fund is up over 26% with Baillie Gifford China up even more since we bought into it. In terms of which global economies which have been able to step ahead of the Virus and provide confidence to investors, China has led the way, with Japan not far behind. Both China and Japan seemingly have the virus under control for now and their economic position seems built on firmer footings than many in the West. It is for others to debate the moral position on China, but there is no doubt that it has been a strong contributor to our portfolio performance throughout 2020.
Sustainable Emerging Markets
This leads me neatly onto my final point for this update, which is some good news about a new ethical fund launch. For years we have harangued fund managers for greater fund choice when it comes to sustainable Emerging Market funds. JPM have recently advised us that they are launching a version of their offshore sustainable emerging markets fund which will be available for our investors. This is fantastic news as the JPM Emerging Markets funds, both growth and income, have been star performers in our client portfolios in recent years and so to have access to a sustainable fund which is built on similar investment credentials is a huge plus for our ethical portfolios. We are hoping to have access to this fund over the next couple of months and we will be able to enter on a very competitive charging basis as well, which is all round good news for investors.