Investors’ hopes for a global economic recovery continued to grow over the first quarter against the backdrop of a rollout of Covid-19 vaccines. Equities globally gained ground while bond yields and inflation expectations rose, led by the US where President Joe Biden confirmed a fiscal stimulus package of $1.9 trillion. This was followed up with an additional promise of $2 trillion in infrastructure spending.
Lowly-valued and economically sensitive equities extended the recovery they enjoyed at the end of 2020, with energy and financial stocks leading many markets higher. UK equities kept pace with the recovery, while some domestically focused areas responded particularly well to good progress with the country’s vaccination programme and an improving economic outlook. This progress was reflected in the strength of sterling, which also gained against a strong US dollar.
In our portfolio, companies exposed to the energy transition - where demand is increasing - were amongst the leading contributors to performance over the quarter, such as chemical and sustainable technology firm Johnson Matthey and diversified miner Anglo American. Meanwhile, on the digital front, education publisher Pearson is progressing further towards a digital future that offers growth opportunities. Another top contributor was newly bought online gaming operator Gamesys, which owns Virgin Casino and Jackpotjoy, on the back of strong results and a bid approach, with US casino operator Bally’s agreeing key terms of the £2bn takeover in March.
On the negative side, our underweight positioning in the banking and oil & gas producer sectors relative to the index was a drag on performance. This largely resulted from not owning HSBC, Barclays or BP. Both sectors rallied on the expectation of an economic recovery as discussed above.
Portfolio activity over the quarter included the sale of our large holding in G4S following the conclusion of the bidding war for the company, while scaling backing positions in British American Tobacco (in favour of more compelling opportunities) and Pearson (off the back of strong performance). We initiated positions in certain companies exposed to economies reopening, including bus and coach business National Express, science, tech and engineering (STEM) specialist recruiter SThree and flexible office space operator Workspace.
What have investors learnt from the past year? What have investors learnt from the past year and what could it mean for the future?
Global markets experienced a record-breaking crash in February and March 2020 as the Covid pandemic spread the world. However, with governments and central banks doing ‘whatever it takes’ in terms of providing support to individuals and businesses through monetary and fiscal policies, as well as a quick breakthrough in developing an effective vaccine, markets rebounded fast. They recouped their losses at a global level in five months when previous declines of this magnitude would have taken up to two years.
We think there are five key lessons that investors have learnt over the past year.
- Maximum fear = maximum returns. March 2020 was a good time to be a contrarian investor[1]. As the coronavirus pandemic swept into the west and equity markets went into tailspins, those who held their nerve were rewarded handsomely as market levels bottomed in March 2020. There have been very sharp returns since then.
- ‘Don’t fight the Fed’ is a well-used mantra for good reason. Monetary and fiscal support, from central banks and governments respectively, in the US and the rest of the world, has been significant and cushioned the economic blow as well as supported financial markets. However, this stimulus brings future risks – of inflation and future tax rises to pay for the crisis.
- Past performance is not necessarily a guide to future performance; early Covid crisis winners were stay at home beneficiaries (technology and growth companies, defensive stocks such as utilities, consumer staples and pharmaceuticals). In the subsequent ‘recovery’ phase, the best performers have been back to work stocks (commodities, oils, leisure and airlines, banks).
- When the tide goes out people are really reminded of the importance of balance sheet strength and how vulnerable even businesses that otherwise seemed ‘steady’ can be to exogenous shocks.
- Investors could maintain some diversity in their portfolios. Valuations matter and there are current signs of market exuberance to be aware of – high levels of retail participation, record numbers of company flotations via ‘SPAC’ (special purpose acquisition company) structures in the US – which could bring the risk of market setbacks or volatility.
How do these lessons influence our thinking going forwards?
We are aware that the pandemic is likely to have structurally changed the way that consumers and businesses behave in future, so we do not anticipate a full reversal of behaviours back to those seen in 2019. For example, workers are now likely to work remotely/ from home significantly more often than they did before. This is likely to benefit our holdings that contribute to ‘digitisation’ such as Pearson and Avast, and new holding Workspace, a provider of flexible workspace.
However, as the world returns to a degree of normality, we would expect to see strong performance from more cyclical industries that have been impacted by lockdowns. Since the Pfizer vaccine announcement on 9 November 2021, we have started to see signs of improvement here with consumer confidence rising across the globe. In the UK specifically, the reopening of the economy, the Budget’s renewed support for workers and businesses and rapid vaccine rollout have boosted UK consumer confidence to the highest level since before the first lockdown last March. This has fuelled hopes of a spending rebound in the coming year. If this improved mood translates into higher spending, it could help to repair some of the damage the pandemic has caused to the economy. Here, our holdings in luxury goods company Burberry and budget hotel operator Whitbread and coach operator National Express are set to benefit.
However, risks do remain. The slow vaccine roll-out and third wave in the EU, as well as coronavirus variants emerging across the globe has cast some doubt on the pace of unlocking economies. Additionally, the fiscal and monetary stimulus thrown at the situation over the last twelve months has been unprecedented and could well lead to higher inflation and bond yields.
The ‘lower for longer’ interest rate conditions of the last decade since the Global Financial Crisis have supported valuations in higher growth areas of the stock markets and weighed on the performance of interest rate sensitive sectors such as banks and life insurance. Higher growth stocks have become highly valued in large part because of the significant cashflows they are expected to return to investors long into the future. Interest rates are a key component of the discount rate at which an asset’s cashflows are discounted in order to compute their value in today’s money, or present value. For companies with into the future, a lower discount rate enhances their present value by more. A change in this regime could benefit these interest rate sensitive sectors which typically benefit from interest rate rises such as life insurance companies Legal and General and Prudential, and telecoms provider BT.
Another feature of the large amount of central bank stimulus is that it can lead to distortions and “frothiness” in some areas of the market. This has typically impacted stock markets with a large weighting to technology companies, such as the US. The UK does also display signs of frothiness in some areas though, with a number of recent market floats coming at high valuations. These have typically been companies that have traded relatively well during lockdown (e.g. Deliveroo and Dr Martens) but which we have not found appealing to invest into date. This contrasts with many existing market constituents remaining on attractive valuations particularly against global peers. Our disciplined process, focused on mispricings generally leads us to avoid investing in these ‘frothy’ areas of the market, preferring to focus on more out of favour, mispriced assets.
Any company references are for illustrative purposes only and are not a recommendation to buy and/or sell, or an opinion as to the value of that company’s shares.
The article is not intended to provide, and should not be relied on, for investment advice or research.
[1] Contrarian investing is an investment style in which investors purposefully go against prevailing market trends by selling when others are buying, and buying when most investors are selling.
