Our overall view of investment markets remains bullish, particularly for equities and high yield. A combination of government spending and corporate results largely justifies the recovery in equity markets over the past year and there is no obvious sign of tightening policy, with pent-up demand during lockdown still to be let loose on economies. While there are potential hazards, from growth disappointments, through virus mutations and vaccine bottlenecks, to the mounting spectre of inflation, reasonable valuations outside of US mega caps means there are ongoing reasons to be optimistic.
We are increasingly comfortable adding UK equities to our favoured ‘cheap against the US’ collection of markets, particularly with Brexit finally in the rear-view mirror. One thing recent years have shown is that a healthy macro backdrop is not a prerequisite for positive equity performance, and the UK looks set to test this theory to the limit over the next few months – albeit with an encouraging roadmap for exiting lockdown now in place. After a bounce in Q3 last year, renewed lockdown sent service activity – which constitutes the majority of UK GDP – into negative territory again, dragging the composite Purchasing Managers’ Index well below 50. Government consumption (healthcare and education spending) pulled fourth-quarter GDP up to a better-than-predicted 1.2%, avoiding the dreaded double-dip recession, but the overall 2020 decline of 9.9% leaves the economy back at 2013 levels.
Despite encouraging vaccine rollout progress, the UK is among the regions where the International Monetary Fund (IMF) predicts activity will likely remain below pre-pandemic levels until 2022 and we should brace for tough economic times ahead, with unemployment clearly much higher than furlough-obscured headline figures suggest. A recent British Chambers of Commerce survey showed one in four jobs are at risk if furlough was to end and the early March Budget attempted to balance this short-term risk with the post-Covid structural change that has to be faced, extending the scheme to the end of September and broadening its scope.
Borrowing figures showing the first January deficit in a decade are another reminder of the current state of UK plc but, given that the Bank of England remains in accommodative mode (although negative rates seem less likely), these are ultimately just numbers for now, however frightening they might appear. Where they might become more relevant is if vaccine rollout and post-lockdown activity sparks a stronger-than-expected resurgence in the second half of the year, confounding IMF predictions, and rising inflation forces the central bank, and others, to move back towards a hiking mindset much earlier than thought possible. Concerns are increasing that any such volte-face, or even talk about turning off the stimulus taps, could spark a taper tantrum in markets similar to that seen 2013, when the prospect of hikes after a protracted lower for longer period spooked equities.
This kind of economic prognosticating should not determine asset allocation, however. Rather than trying to get into the heads of central bankers and time moves into or out of markets, the only real protection is to keep a properly diversified portfolio at all times.
We asked last month whether Elon Musk becoming the world’s richest man might ultimately prove the top of the market for certain sectors, and – with hubris apparently working at breakneck speed these days – falls in Bitcoin over February saw him relinquish the title back to Amazon’s Jeff Bezos. Beyond obvious and well-covered bubble areas such as Bitcoin and GameStop, however, there are other signs of froth emerging. These include record levels of venture capital funding flowing into markets, with an all-time high of close to $40 billion in January, focused primarily on tech areas such as robotics, logistics, automotives, fintech, and cloud computing.
There has also been a huge spike in so-called special purpose acquisition companies (SPACs). These are created solely to merge with or acquire another business and take it public; encapsulating the immediate gratification expected in today’s world as they are a cheaper, faster alternative to the traditional IPO route. Investors essentially write blank checks to SPACs, which can take up to two years to target and buy another firm, and critics are warning this activity is flooding the market with cash to the point of absurdity.
In the US, equity prices are around 15% above pre-pandemic levels and house prices are rising at the fastest pace in nearly a decade, pushing the household wealth-to-income ratio to all-time highs and providing support for a consumer recovery. Against this, these bubbles continue to pose questions about potential fallout if the broad rally in risk assets reverses. Investors are increasingly having to balance concerns about higher inflation against the Federal Reserve’s pledges of continued support, with bonds selling off aggressively towards the end of the month as a result.
While markets were far from risk off in February, we also saw another sizeable correction in technology stocks, with Tesla – widely considered the canary in the coalmine when it comes to stretched valuations – among the companies slumping as businesses expected to do well in improving conditions sustained their rally. Value names also continue to perform well and, as we wrote towards the end of last year, we are confident our long-term positioning is beginning to bear fruit, particularly if that twin spectre of inflation and higher rates puts US technology valuations under further pressure over the months ahead.
Japan has fallen off many investment radars over recent years, with the country long in the thrall of deflation, but it remains another of our favoured cheaper markets. Signs of life have emerged in recent weeks, with the Nikkei breaching the 30,000 level for the first time in three decades in February as the country’s economic recovery from the pandemic continues. Fourth-quarter GDP figures were well ahead of expectations, sparked by so-called revenge consumption as people make up for lost time during the pandemic. While a drop off is expected in Q1, with a state of emergency declared in several prefectures, consensus suggests this should only be a temporary setback.
Along with much of Asia, Japan is benefiting from its first into, first out of Covid situation and effective management of the subsequent waves of the disease, with GDP shrinking 4.8% in 2020. This ranks the country among the most resilient in the world last year, with less than half the 9.9% contraction suffered by the UK for example.
Looking to the rest of 2021 and beyond, the country is continuing its attempts to stage the delayed Tokyo Olympics while wrestling with the pandemic. We are confident Prime Minister Yoshihide Suga will keep the fundamentals of his predecessor Shinzo Abe’s policies intact and continue to bring greater focus to Japan’s growth strategy backed by a digital revolution. With a large proportion of export-driven businesses, the country is well placed to benefit from a global economic rebound, and the structural reform Abenomics ‘arrow’ is starting to pull Japan out of its long slump.
Please remember that past performance is not a guide to future performance and the value of an investment and any income generated from them can fall as well as rise and is not guaranteed, therefore you may not get back the amount originally invested and potentially risk total loss of capital.
This document should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice.