Economic Performance & Outlook
John Maynard Keynes said, “when the facts change, I change my mind.” That’s key to understanding the way financial markets are operating now.
With a range of vaccines now projected to have significant success in protecting individuals, that’s information enough for the market to consider life beyond the worst of Covid. From that perspective, 2021 should be a mirror image of 2020, with concern about the effects of the pandemic dissipating as the year continues.
Our attention now turns to the longer-term consequences of the pandemic, because the economic disruption, and the shift in the way we live our lives, will be with us for some time.
To anyone magically transported from January 2020 to where we are now, the likely biggest shock would be the extent of government intervention in our lives. Government spending has ballooned both in relation to the medical task at hand and in propping up much of private enterprise. The focus for governments will be to rein in spending as quickly as possible, probably combined with tax rises. Timing will need to be carefully balanced not to damage any emerging recovery.
The other major ongoing shift is the extent to which our lives now take place online or in a virtual environment, a trend that predates Covid, but has been hugely accelerated by it. If we thought we were too focussed on screens a year ago, we’re going to horrified by our current screen-time averages. Shopping, business and entertainment have in large part migrated to the online sphere, with a consequent knock-on effect for the shops, offices, transport companies, hotels and entertainment venues that have seen their business collapse.
Stock markets, particularly in the US, have been buoyed this year by those technology companies that have benefited from our enforced change in activity. Their rapid growth has however all of a sudden caught the attention of regulators, and, like a dam bursting, the challenge to these businesses from the authorities is gathering pace. In October the US Government began antitrust proceedings against Google, while this month the Federal Trade Commission along with many US states took Facebook to court for alleged anti-competitive tendencies. The Financial Times reported on 15 December that the EU is threatening to break up the businesses of the big tech firms, while the New York Times recently ran an opinion column entitled ‘Facebook has become a menace’. The knives are out.
As an Irish company, it would be remiss not to make a nod to the Brexit trade discussion debacle taking place as we write this note. The lesson to be learned from this is that the global direction of travel is towards protectionism, restrictions and barriers to trade.
How does this all play out from an investment viewpoint? With low-risk government bonds almost un-investable because of the artificially low yields, our strategy is to hold a core amount of equities with other assets judged against them. And while low interest rates drive higher valuations for other assets, any unwinding of this may be years into the future. In summary, we are still finding it difficult to be bullish about markets generally, but recognise the need for long term investors to retain exposure to return seeking assets at this stage in the cycle, especially in the context of negative yields on short and long term core bonds.
Bond performance over past year
All bonds 10+ years, 11/12/2019 – 11/12/2020, local pricing
For a rational investor it is simply impossible to be enthusiastic about high quality fixed income, with yields either ridiculously low or falling into negative territory. The US 10-year Treasury yield collapsed from near 2% to close to 0.5% in the first half of the year – it has since recovered somewhat but is still hovering below 1%. The German 10-year yield, which dipped close to -1% in March, remains below -0.5%.
On a more positive note, credit spreads have come down indicating increased confidence in this market, but not to the same extent of recovery as demonstrated in equities. We continue to believe that emerging market debt may hold some opportunities and should also aid in the diversification of a portfolio.
Equity performance over past year
11/12/2019 – 11/12/2020, local pricing
At the start of the year many were arguing that equities were already looking expensive. After toppling precipitously at the beginning of the Covid crisis, those equities have now recovered, with significant gains over the year as a whole. This might seem odd given that we are in the midst of a pandemic that has shattered economic growth, trade and a number of key industries over the past few months, and is likely to continue this pattern well into next year. Indeed there must be some froth based on the relief in markets that a successful vaccine programme could put this crisis behind us.
As we discussed in one of our webinars earlier in the year, there’s an argument to be made that the amount of government support is so colossal, and the money being pumped into the economy is so significant, that pent up demand as we emerge from the pandemic will justify some of the prices being paid for companies.
For Acuvest, the outlook means that we have reverted to a neutral position in stocks, primarily on the basis that a re-rating of markets generally may well be some years away.
Ongoing bad news for retail and a degree of uncertainty about the future demand for offices doesn’t bode well for the European property sector over the short to medium term. We struggle to recommend increased exposure to property in the short term, but the prospect of reasonable returns and a degree of diversification warrants its inclusion in portfolios over the medium to long-term.
Commodity performance over past year against equities
11/12/2019 – 11/12/2020, US dollars
Oil prices remain weak – an unsurprising outcome in the present situation. The price of Brent crude, which dipped as low as $20 in the early part of the Covid crisis, now trades at roughly $50, a good 20% lower than where it was at the start of 2020.
There may be opportunities for some metals in the switch to renewables, with the price of copper up over 20% this year.
Hedge fund performance over past year against equities
11/12/2019 – 11/12/2020, US dollars, hedge funds priced monthly
Hedge funds in general still don’t seem to be generating the above-par returns that would justify their fees. That said, they can be useful defensive investments when markets reverse.
Sharp movements in currencies in recent months have given some opportunities for gains (and losses) in recent months. These funds continue to be a useful diversifier.
Global Tactical Asset Allocation Funds
Again, we value these funds for their diversification potential rather than their return capabilities in recent times.
While these securities are potentially exposed to a higher degree of default risk than investment grade bonds that benefit from ECB support, they do provide a premium over cash to reward for illiquidity and the credit risk. In addition to this they offer a degree of diversification from the traditional asset classes and, as they are floating rate in nature, also provide protection against future increases in interest rates, although this is not a concern for the time being.
Portfolio Structure & Risk Management
- It is very important that clients have a disciplined management framework for determining how to structure portfolios and how to adjust that dynamically over time.
- Acuvest recommends that portfolios comprise a diversified mix of asset types which balances the desire for high returns with management of the associated risks. For this purpose, we group assets into three categories: growth (including equities and property), managed risk (including global tactical asset allocation funds, certain types of hedge funds and sub-investment-grade credit risk) and defensive (including bonds and cash).
- Given the extent of the recovery in markets despite the uncertain outlook for economic and corporate profitability growth we reverted to a negative stance in August. On the basis of the improved outlook for a recovery in economic activity as vaccines begin to be rolled out, and the continued support from political leaders and central banks across a significant proportion of world’s economies we have advised clients to shift back to a neutral position on equities. Our current central expectation is for high levels of volatility to continue through the rest of this year and we continue to advise clients to look on dips in the market as opportunities to rebalance, thereby selling high and buying low around a neutral central position. An environment of low returns and high volatility we continue to advocate the benefits of having a well-balanced and diversified portfolio, and continue to work with our clients on finding attractive investments in credit and infrastructure.