• ChetwoodWM

Client Update - 5th February 2021

January closed out with Asia and Emerging Markets leading the equity returns once again, and developed markets and bonds losing their way to an extent. Bond returns saw volatility as the expectations of the “build back better” economic stimulus programmes from the new US President Joe Biden weighed on bond yields. Diversity was key for our portfolios in January, with an overweight in Asian equities adding considerable value against a mainstream balanced strategy of bonds and developed market equities, which struggled.

Much of our investment philosophy has been built on the premise that you need to be dynamic and flexible, but you also need to rethink what you thought you knew. If markets have not had to cope with a global pandemic of these proportions before, maybe you need to consider different ways for managing portfolios. Much of our current work is on finding new alternatives for our portfolios as bonds may not prove to be as defensive in 2021 as in previous years. Short term inflation and central bank policy are key here.

The risk to markets in the last two weeks has focussed on the retail investors versus hedge fund short sellers we wrote about previously, with the short sellers having to close their positions and fund losses, potentially by liquidating other assets to raise cash, hence driving volatility. At the extreme there could be some huge realised losses at hedge funds. Credit lines from banks are likely to be drawn and there are already reports that this has happened in relation to one of the larger retail trading platforms in the US.

The other aspect of the retail investor phenomena we wrote about, is that it probably reflects the huge amount of cash around. As a result of quantitative easing, fiscal stimulus and a lack of spending opportunities, we now see higher US savings balances and money has flowed into US equities. Some of this is evidently of a very speculative nature and may even be driven by motives other than making a quick buck. It is a side effect of liquidity, yet it is not a true reflection of the underlying fundamentals. The development of technology and the abundance of liquidity has allowed speculative activity in the stock market to emerge to an extent that is surprising. It will cause damage, financial and reputational, and will solicit some political reaction. However, taking liquidity away is not the answer. I suspect there will eventually be more of a Darwinian end to what we are seeing at the moment – the opportunities for squeezing short sellers will shrink as short-sellers fear the squeeze, which means less opportunities for the social media-driven retail investors to cause disruption. Some will win out of it, others will lose. Overall, the activity has very little to do with macro or corporate fundamentals.

We have said for a few months now that equity markets look attractive in 2021 with the rise of global vaccinations, however it often the unknown or unexpected that causes volatility and a revision to our views. We are monitoring this volatility, but we are not afraid of it. Indeed, the pull back last week has offered our investment team opportunities that they have taken advantage of, especially in the energy sector. Monetary policy support (illustrated by real interest rates remaining very low) and expectations of economic recovery remain the key drivers of equity market performance. Therefore, key risks continue to be a rise in real interest rates in response to concerns about the growth in global debt levels, or if earnings growth forecasts underwent a significant downgrade. Do not panic. The view remains that vaccines will pave the way to better economic conditions which is a supportive view for earnings and market performance, although last week’s market volatility will undoubtedly keep raising its head along the way.

Of course, we keep monitoring risks to this view. It is evident that the roll-out of vaccinations is disappointing in many countries and supply and logistical problems that have been discussed, are showing up in reality. There are also the epidemiological concerns about the infectiousness and deadliness of new strains of the coronavirus. This in turn leads to potentially longer periods of economic activity being below capacity and scarring from a year of rolling lockdowns and more businesses being shuttered than we might have thought. The last thing the US Federal Reserve (FED) and the European Central Bank want, when they are focussed on supporting the recovery, is a financial shock coming from the antics of anti-establishment retail stock investors pitting their wits, and money, against short sellers. Note that FED Chair Jerome Powell gave nothing to those looking for the FED to start talking about tapering. If the going gets tough again, the central banks will ramp up support. Do not bet against the FED.

We must not forget that the message from the Q4 earnings season has been encouraging. What started with the banks reporting good numbers, has continued with big-tech also demonstrating that it can continue to grow earnings. From the S&P500 Technology sector, revenues for Q4 have so far surprised by 7.3% while earnings beat expectations by 20%. As long as bond yields remain low, these valuations can be sustained, and growth stocks will continue to reward. Q4 looks like being the third consecutive quarter for the S&P500 in which earnings surprises have been positive by at least 18%.

We remain of the view, however, that beyond short-term volatility, the fundamentals of low real rates and earnings growth remain powerful. There is cash waiting to be invested and a buy-on-dips response would be our expectation if bond yields and equity prices see further downward moves in the days and weeks ahead. We are excited about the opportunities being presented to us and we will take advantage of them when they arrive. Have a good weekend and please do get in touch if you have any questions.

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