Log inMarket Update 4th March 2021 from Jilly Mann
We have somehow arrived in March 2021 with a relatively optimistic outlook in the offing for the UK. I say somehow arrived at because, with lockdown persisting at least in the short term, time does rather pass unheralded. In this update, we shall cover the following topics, which hopefully shed light on why stock markets appear to have been pausing for breath in recent weeks, but also why we believe there are grounds for optimism from here:
- UK optimism
- Gamestop – what it all meant
- US Bond Yields and the Federal Reserve response
- Opportunities and risks within emerging markets
- Prospects for resources through 2021
UK optimism
2021 so far has felt something of an unpredictable ride for investors. After the strong returns seen during 2020, there is always a hope, if not an expectation, that markets will just continue to rise unabated, however, that rarely happens. That said we continue to believe that the UK really is leading the way when it comes to the COVID-19 vaccine rollout, the roadmap out of lockdown and a path for economic stabilisation if not recovery.
Rishi Sunak has just delivered his Budget address and despite the inevitable drum beating amongst the media that tax rises and allowance cuts were inevitable, he has produced a pragmatic Budget, which logic suggested was the only option. In the wake of the pandemic the UK has undoubtedly larger national debt to repay, but the reality was that to have introduced swathing tax rises would only really have hurt the industry and individuals who are required to help rebuild the UK economy, whenever it fully reopens for business. Imposing such hits when the economy effectively remains largely closed never felt right in terms of timing or approach.
Rumours over significant changes to capital gains tax or indeed the imposition of a wealth tax have also not come to pass, for similar reasons. Whilst we can see a future beyond COVID-19, now was not the time to create too much ill will across the electorate. That is not to say that the increased rates of corporation tax or frozen income tax bands are insignificant, but before Mr Sunak can build an economic recovery, he needs to stabilise the economy and this Budget felt very much like step one of the stabilisation phase.
Now that we have had the Budget and uncertainty over fiscal policy has largely dissipated, attention can turn to the areas of the UK economy with a clear mandate for growth. If one takes the announcements on Freeports, green technology and home ownership, there are clear incentives for businesses in these sectors to invest capital and be rewarded. In turn that should feed through to the UK stock market, which remains one of the only markets in the world with any level of confidence over the world post COVID-19. We now have target timescales for the end of lockdown, we know the vaccine is working to date, we know that the rollout will continue at pace and we know what support Mr Sunak has in place for the country over the next couple of years. The irony is fast becoming that for all the European resistance towards Brexit, it is Europe that is being left behind with an appallingly disjointed and bureaucratic approach towards the vaccine rollout. History may well view the respective ability of the UK and the inability of Europe “to get jabs done” as the saving grace for Boris Johnson’s Brexit crusade.
For a long time the UK stock market has threatened (but not delivered) world leading growth and whilst it has by no means been a laggard in terms of individual stocks and sectors, it has been the most unloved developed market in the world in recent times. This contrasts strongly with more exciting US technology companies, Amazon, Netflix and Zoom to name but a few. In the last year the US and the fast-growing Asian economies have dominated stock market returns, whilst the UK remained embroiled in Brexit uncertainty. We aren’t ready to denounce US technology nor the Asian growth story, as both consistently outperform in spite of themselves rather than because of the structural strength of all of their component parts. However, at present there are more reasons than in recent memory to believe that the UK now has an ideal opportunity to deliver strong returns over the coming year.
If you have followed the stock market this year, you may think our view is optimistic based on 2021 returns to date. The chart below compares the return of the FTSE 100 (red line) versus the JO Hambro UK Equity Income fund (blue line) from the 1st January 2021 to date.
It is clear that 2021 has not been a straight run upwards so far and this has reflected in portfolio valuations for the year, but the diversion between the two lines in the latter part of February is also instructive. Whilst the FTSE 100 is up 2.8% for the year, the JO Hambro fund is up 8.29% over the same time period. This is simply due to stock selection and understanding into which companies and sectors in the UK it is best to invest now.
If we were to plot our other UK equity holdings on the same graph, you would see all of them significantly outperforming the FTSE 100 for 2021, so whilst it may at times feel like stock markets have run out of steam and headlines talk about bubbles bursting so frequently that in the end it must happen, the reality is that we don’t think we are yet in bubble bursting territory. Whenever uncertainty abounds, we will experience days and potentially weeks of fairly short, sharp movements. Once certainty prevails, one way or the other, markets reward investors and we have been increasing our exposure to our UK funds in recent weeks, ahead of the Budget, to hopefully benefit from this increased certainty.
We have held meetings with all of our UK equity fund managers this year and are clear that they are positioned sensibly for the next phase of the economy reopening. The Chancellor’s Budget announcement further strengthens that view and we expect the less exciting areas of the UK stock market, the workhorses who power industry, infrastructure and home ownership projects to reward investors. The additional upside we expect to see from stocks held within funds such as JO Hambro, Threadneedle and Schroders is an increase in dividend pay-outs later this year. Dividends were largely cut or reduced last year as the pandemic hit, but the cash which would ordinarily have been distributed to investors is largely sitting there waiting to be distributed this year and managers are expecting a 30-35% uptick in dividend pay-outs, which will also feed through to overall fund returns.
Gamestop – what it all meant
Despite our optimism on the UK stock market and the plan for a COVID-19 exit, it would be remiss not to highlight some of the uncertainties which remain in global markets and Gamestop has to be the first port of call.
My guess would be that Gamestop was hardly a household name until January this year, but for a brief time it became all that markets were worried about. I tried to plot the performance of the major US indices; the NASDAQ 100 and the S&P 500, onto the graph below, but the movement of the Gamestop stock was so extreme (ups and downs of 1700%) that it completely smothered any comparator.
Gamestop became the poster child for individual investors waging a war against hedge funds and corporations who profit from inflating and deflating stock prices day in day out, to the disadvantage of the everyday investor. Or, at least that was the rhetoric. Gamestop may well be one of those moments we look back on in history and wonder what the fuss was all about, but as you can see from the above graph, with the share price snaking upwards again, it hasn’t quite gone away yet.
The concern for markets was that the tactic of individual investors clubbing together to artificially inflate a failing company’s stock price to outlandish levels could become infectious and the tactic then used against lots of stocks across the globe. We briefly saw a similar tactic towards silver miners employed shortly after Gamestop, although the impact was comparatively minor and it resolved itself as quickly as it started. Overall, markets have reconciled themselves with this sort of activity and unless we see this happen again on a much larger scale, it feels like an episode heightened by this cathartic urge for a stock market bubble to be realised rather than a moment to actually burst any bubble.
The Gamestop episode does, however, highlight the continued impotence of Regulators to control events such as these with anything other than retrospective action, by which time the technology wizards who create these scenarios have already moved onto their next ploy. Perhaps another example of how looking back on the past as a precedent for the future is rather limited in investment markets. Technology has simply moved on so much that comparing what could bring down stock markets today against the causes of the Wall Street Crash of 1929 or the recession of the 1970s provides a flawed debate.
US Bond Yields and the Federal Reserve response
Another headwind for global markets in 2021 has been rising US bond yields. Bond yields are a complex beast and not one I shall describe in detail, but in essence rising bond yields can signal a resurgence in inflation, which is often seen as a headwind for economic growth and a negative for equity ownership. For a long time, interest rates and inflation across the developed world have been kept at all time low levels. The Chancellor of the Exchequer has today restated that in the UK, a single percentage point increase in either interest rates or inflation would cost the UK economy £25 billion. That is a huge figure and would be multiplied much more so if applied to the US economy, so in short, Central Banks and Governments need to keep interest rates and inflation low for their own benefit, repaying the debt which has spiralled due to the pandemic is simply not feasible, if either interest rates or inflation rise out of control.
So therein lies the internal struggle for the global economy, a struggle which has the US bond market as the bellwether for the future direction of markets. The 10 Year Treasury Bond Yield reached a high of 1.6% last week after a fairly consistent rise upwards, but has retreated this week to around 1.48%. The graph below demonstrates how yields fell sharply as the pandemic hit and how yields have then risen through 2021. Higher yields during more stable economic times are not necessarily a concern, but rising yields during a global pandemic and economic lockdown is where the problem arises, because if yields rise too fast during recessionary times, stock markets would weaken and could well fall, thus exacerbating the already delicate financial position across the globe.
The US Federal Reserve made noises last week that if it needed to intervene in the market to stymie the rise in bond yields then it would do, but it didn’t take immediate action. Often, such announcements are in themselves sufficient to calm markets, but last week, the bond market didn’t seem to pay much attention. This week, things seem to be falling back in line with where Central Banks need rates to sit, but we expect concern over bond yields to rumble on in the weeks ahead.
Alongside Joe Biden continuing to try to pass his COVID-19 stimulus package through the Senate, bond yields will dominate markets for now and if they do turn upwards again, we would anticipate some rhetoric and reticence from Central Banks against intervention, before pragmatism sets in and action is taken to force yields lower again. Stock markets won’t like this period of debate, but ultimately they will like lower yields and so we may experience short term volatility for a longer term solution, which remains positive for global equity markets, where equity ownership remains one of the only attractive options left open to investors who seek a return on their capital.
Opportunities and risks within emerging markets
We continue to believe that emerging markets could well rally in the months ahead, with China still offering an engine for global growth, however, we have reduced some of our Chinese allocation further in the near term. We wouldn’t necessarily expect China to tighten their economy if the rest of the globe is managing to ride out the pandemic by generating further growth, and we do continue to see plenty of growth potential in China, but we have diverted some of our Chinese exposure to top up our Miton US Smaller Companies holding. This may seem counterintuitive given the challenges the US faces, as highlighted previously, however, we saw an opportunity to buy further into a fund which has returned 13% for the year so far in spite of the global challenges. We maintain the view that smaller companies have the advantage in leading economies out of recession and we feel that in the near term, the US Smaller Companies fund offers similar growth potential, but for perhaps less risk, than some of our Chinese weightings.
Within fixed income, we have also removed our allocation to emerging market bonds. Emerging market bonds have really underwhelmed over the last year despite there seemingly being a good environment for them to flourish. They also tend to react quite extremely to shifts in US Dollar movements, which may come to fruition in the weeks ahead and so we have reduced our exposure and in turn the risk associated with them for now.
Prospects for resources through 2021
Finally, we continue to keep our resources allocation under review. We already have significant exposure to basic materials and oil & gas through our existing funds, such as Schroder Income and the JO Hambro fund. The resources sector per se has been quite volatile through 2021 to date. The price of Brent Crude Oil soared by nigh on 25% at its peak this year, but the gold price fell by 11% at the same time. If we see a period of markets steadying then, we may see an opportunity to buy back into a resources fund at a more consistent price, but for now we have been content to trust the managers within the portfolio to stock pick the best value resources assets and hold them there rather than own a specialist resources fund.
With the latest push in the UK towards green energy, we would expect to see optimism return to the clean energy sector, which should only strengthen ties with the US and Joe Biden’s Green New Deal, but as I mentioned in the last update, green energy stocks had reached some fairly high points earlier in the year, these have corrected somewhat, but we want to see these come in to a more realistic and sustainable level before buying back in. Undoubtedly though, the green energy agenda is one in which Developed world economies are intrinsically piggybacking the COVID-19 recovery and so this is an area we expect to feature heavily in portfolios in the months and years ahead.
Hopefully this update provides some clarity as to the challenges facing markets through 2021 so far and brings to life your portfolio valuations as they are today. We remain optimistic for 2021, but this optimism relates to certain stocks in certain sectors. Of course, if Central Banks lose control of monetary policy or investors panic and try to expedite a bubble bursting, then market fluctuations will happen, but for now there appears to be enough will and logic across Central Banks to see out this period and use investment growth as the means of rebuilding global economies in a post pandemic world throughout 2021.