Client Update - 19th February 2021
After a drab month, UK markets had a better start to the week on the back of talk starting to turn to what Boris has in store for us on Monday when he addresses the nation on the path out of lockdown. Subsequent information “released” to the market appears to suggest a slow and prolonged release and a continued dialogue of “if you can, work from home”. We will see and I fear my update next week may be rather more dominated by COVID news.
Markets overall have been solid year to date, however we remain focussed on two key cyclical drivers of markets and sentiment. These are longer-term interest rate expectations and earnings growth. In recent months, both have risen and this has supported a “reflationary” theme and the occasional outperformance of value equities – such as financials and energy. The US Treasury yield is probably the most watched financial indicator in the markets and forms a key part of our investment modelling.
Excluding the period of market turmoil as the world went into lockdown last March, the lowest level reached by the US Treasury 10-year yield was 0.50% on 6th August last year. It has since risen to 1.51% due to market expectations of rising inflation as a result of a strong post-COVID growth surge and from central banks continuing with a liquidity programme and ignoring the effect on inflation, for now. The 7-10-year US Treasury bond index delivered a -3.33% total return over that period while the S&P500 total return was 17.8%. So quite a big increase in long-term rates did nothing to undermine equity market performance. This is good news, but we remain aware of other recent examples that have not been such good news for equity investors, as it pays to not be complacent.
These short-term rises in rates have been seen before, most recently in 2013. The US Federal Reserve (FED) is undoubtedly aware of this. The 10-year yield rose by 140bps between May and September 2013 on the view that the FED would scale back its asset purchases post the great financial crisis. Back then the FED only held about 20% of outstanding marketable Treasury securities compared to 34% today. Yields went higher and the equity market had a 6% set-back between May and June. Evidence from FED dialogue today suggests that they are well prepared to react to any market expectations of them reducing liquidity. After the rise in yields in 2013, it was not until the beginning of 2015 that yields had returned to their pre-tantrum levels. A period of higher long-term yields when there are uncertainties in the outlook is not what the FED would want and we feel they have learnt from 2013’s policy “error”. So, in summary, rates are rising, but we feel that central banks understand the reasons for this and are unlikely to tighten liquidity any time soon, so equity markets can make good progress from here.
Last week, President Biden signed his “Buy American” executive order. As part of this he pledged to replace the entire Federal government’s vehicle fleet with electric cars and trucks, all to be made in America. According to one article, citing the General Services Administration, the Federal fleet consisted of 650,000 vehicles in 2019, split between the military and civilian agencies. That is a lot of electronic vehicles to produce. Electronic vehicles are big drivers of demand for semi-conductors and there is a massive shortage of chip capacity currently. Demand for electric battery capacity is also sky-rocketing and with it demand for cobalt, a key input into the manufacturing process of batteries. The price of the spot cobalt contract has jumped by over 40% since the beginning of the year. In related news, one of the biggest Chinese producers of polysilicon, the material used to convert sunlight to solar energy, has announced a huge investment to expand capacity. Solar power is part of the value chain in producing green hydrogen – another booming sector – and some of Biden’s Federal fleet might be powered by that fuel technology. Share prices of leading polysilicon producers have been rising strongly, as have those of semiconductor producers and companies involved in the supply chain for electronic batteries. While many people focus on the FAANGS as being the main story behind the rise in stock markets, the acceleration of the energy transition is proving to be a major force behind rising equity prices elsewhere.
Globally, we are rapidly shifting to a lower carbon environment; electronic vehicle growth is huge, and the zero carbon and digital themes intersect on many levels. The world is hugely short technology (as the mixed quality of broadband connections in our zoom-meeting world has demonstrated) and renewable energy (only 2.7% of all new UK car registrations in 2019 were classed as Ultra Low Emissions Vehicles) and will be for years. This remains a central part of our longer-term investment strategy and is representative of our thesis that even though some areas of the market are becoming more expensive, there remains plenty of opportunities for our portfolios in the coming months.