Investment views for 2021 and beyond

Welcome to our first quarterly outlook of 2021. This communication is meant to give you a flavour and insight into the dynamics of the investment markets for the year ahead, and beyond. Naturally, the content of this quarterly update should not be taken as advice for your own circumstances but is a guide to our thinking and that of our investment partners.

As this is a quarterly investment briefing, it is much longer than our normal Friday updates and you will need 15 minutes set aside to do it justice. Most of us have got more time on our hands now I think, so settle down with a drink of what you are partial to and let us lead you on a journey of discovery… and optimism!

As an investment committee we have strong views on certain aspects of the investment landscape, but we are always challenging ourselves to look at alternative views. Working with our investment partners gives us a check and balance which is important and healthy for us and all our clients. Being able to tap into their considerable expertise and research capability is very much appreciated.

Our investment partners are as follows:

LGT Vestra

LGT Vestra (LGTV) is a partnership between the executive partners and the private banking group LGT, owned by the Princely Family of Liechtenstein. They are one of the largest privately owned wealth managers in the world.

Foresight

Established in 1984, they are a leading independent infrastructure and private equity investment manager with c. £6.8 billion of assets under management.

7IM (Seven Investment Management)

This investment management company has grown steadily since its formation in 2002. It now manages over £17billion in client assets via London, Edinburgh and Jersey offices.

LGIM (Legal & General Investment management)

LGIM is one of Europe’s largest asset managers offering investment solutions to a broad range of clients globally. They managed assets of £1.2 trillion in 2020.

Some context!

It’s always important to have some context when we are talking about the future direction of travel for the investment markets. Naturally, I discussed with our investment partners the main dynamics over the last year and, of course, it is pretty obvious what has dominated the headlines… the global pandemic. We are still in the midst of the crisis, albeit in a new phase, but let’s pray that the next phase will deliver more hope and optimism.

I’ve written a great deal of copy over the last year on the pandemic, so I’m not going to repeat what I’ve previously stated. However, there were other issues which influenced and swayed market sentiment. These are listed below:

• The deepest recession for generations – caused not by monetary mismanagement but a health crisis
• The financial response from governments to support businesses and employees was a saviour
• The huge wave of quantitative easing helped governments and economies, albeit at a high level
• UK and US banks are largely well capitalised (following the financial crisis)
• Interest rates and inflation are low
• Stamp duty holiday creates buying frenzy in the UK property market
• Unemployment is rising but, of course, economic data is a lagging indicator
• Some sectors have performed very well whilst others have been very badly damaged
• The development of communication technology has helped businesses survive and others flourish
• A large swathe of the population has been spending less and therefore have built up their savings
• The vaccination announcements and programme of immunisation
• The US elections!
• Huge, anticipated stimulus in the US and Europe – Biden has proposed $1.9 trillion
• 15 Asian countries signed the RCEP in November which created a free trade agreement
• And, of course, Brexit!

What a year!

The outlook for the global economy

The recovery in economic terms has been significant, albeit with huge variances across sectors and businesses. It is very difficult for the lay person to appreciate quite how well many companies are doing, especially when the news flow through the mainstream media is so negative.

It is also interesting to note that many company owners who are doing well are not shouting about their success, not wishing to be insensitive at a time when people are losing their lives. However, on Thursday morning of this week I spoke to three separate business owners who all said that they are doing really well, and business is booming. Two had their best year ever in 2020!

Back in October, when speaking to our investment partners, there was a mixture of views as to the likely outlook for the global economy and indeed equity markets. Then the vaccine announcements happened which was indeed a game changer. Equity prices rose significantly. At our most recent update, all our investments partners were aligned in thinking that the prospects for a broad rise in equity prices is strong, albeit some sectors are showing signs of over-heating in the short term.

We are in a new economic cycle and it is seen by most that we are in the foothills of a recovery. The extraordinary stimulus, it could be argued, may well have condensed this recovery phase into a very short period of time and therefore shares are no longer deemed to be cheap, but this is not to say that they don’t hold good value when you consider the alternatives, such as cash and government bonds.

Inflation is low and the powers that be would like to see an increase. Much depends upon consumers and whether they have the ability and confidence to spend. With the majority saving more money than normal during 2020, and the anticipation of being released out of lockdown, a spending spree could be just around the corner. Inflation will undoubtedly rear its head anyway here in the UK, due to Brexit. This week I spoke to a client who runs a bathroom showroom and he told me that he expects to put his prices up by 15% because he is having to pay more for imported goods from abroad. There is also a supply and demand issue with certain goods coming from elsewhere in the world, but hopefully that will ease throughout the year.

Here in the UK, house prices have boomed and there is nothing like a stimulus and a deadline to generate excitement! However, expect property prices to weaken in most areas as the year unfolds. At some point, we will see capital gains tax rises and, speaking to accountants and tax specialists, along with property experts (the Head of Residential sales for Savills), they are seeing buy-to-let portfolios being unravelled.

Asia looks like it’s going to decouple from much of the developed world. Economic growth hasn’t been as badly damaged in the east as here in the west and, as a result, share prices have responded well. It has also been helped by the Regional Comprehensive Economic Partnership (RCEP) which was formed in November 2020. This involves 15 countries around the world and is made up of 10 South East Asian countries as well as South Korea, China, Japan and New Zealand. This is seen as an extension of China’s influence in the region. Just worth noting that the US withdrew from a rival Asia-Pacific trade deal in 2017. It is reported as being the largest Free Trade Agreement ever. Interesting that here in the UK, we have unwound our agreement with Europe yet in Asia the opposite is happening! Who is right?

On the currency front, the dollar is expected to weaken further and the ‘go to’ currency amongst the developed nations look likely to be the Euro. Yes, the Euro! The Pound may strengthen slightly but it is not believed that there is a great deal of upside this year.

Sustainability, infrastructure and technology are the themes which we have heard a lot about in recent months, and we expect this excitement to continue in the years to come. Huge investment is being committed by governments around the world. The $1.9 trillion recommended by Biden immediately comes to mind with regards to infrastructure and sustainability investment.

Equity focus, by region

Whilst our focus is predominantly around investing in themes, its clearly important to understand the threats and opportunities in each region:

United States

US equity markets have undoubtedly led the way across the developed world thanks to their orientation towards growth and quality sectors. The tech giants have delivered some stellar returns but there are concerns that these stocks may be overvalued, certainly in the short-term. The threat of increased regulation has been casting a shadow over these stocks for the last 2-3 months which has resulted in marked volatility at times.

Whilst technology stocks have distorted returns, it must be remembered that the US is still the largest economy in the world and there are some excellent companies at much lower valuations.

I liked Sanjay Rijhsinghani’s comment (LGTV): “Trump was all about corporate America whilst Biden is all about the consumer”. It will be interesting to see how this plays out when it comes to taxes! Sanjay also went onto say that inflation may surprise on the upside which will test monetary policy. The weaker US dollar will hike the price of imports.

Diversification into smaller companies in the US may be wise at this stage of the cycle for those with the right risk appetite.

China

Our focus at Blue Sky has been to participate in China’s growth by investing in those Asian countries which benefit from China’s strong productivity. We feel that we cannot endorse China’s poor human rights behaviour and, of late, their dealing of the Coronavirus outbreak leaves much to be desired. However, from an investment viewpoint, it is very difficult to ignore this part of the world, particularly now they have created and formalised their new trading bloc.

It is fair to say that it’s very difficult at times to look under the bonnet when investing in China. They largely manage and massage what they want us to know. However, there are some encouraging signs in that they have made significant moves to dampen property speculation. Of most interest to us though, is their commitment to sustainability. Yes, that is right… China and sustainability!

This is partly due to protectionism, partly for health reasons and, of course, fundamentally, because it makes good busines sense. Most of their major cities are in coastal regions and are vulnerable to rising sea levels because of global warming. China is also committed to energy independence via wind power, solar, hydrogen etc and no longer want to be importers of oil and gas. Phoebe Stone (LGTV) stated that China is now the largest investor and user of renewable energy in the world. However, Phoebe and her team are very careful when considering the fund managers they use who have an exposure to China. Due diligence is so important to ascertain the ethics of any such investment.

Europe

Some Eurozone equities have largely underperformed the broader market in 2021 but, like in the US, there are some excellent companies in which to invest. It would appear that the Eurozone, as a region, is giving a mixed picture but with a co-ordinated fiscal and stimulus programme it could benefit from a strong recovery in 2021. Europe could also be a beneficiary of money being recycled away from the US.

Sanjay (LGTV) suggested that when investing into Europe it is larger cap companies and not smaller cap companies that are likely to deliver value. If looking into invest in smaller companies, then the UK looks more attractive.

The big issue in Europe however is the banking sector. The structural problems have not been largely addressed. However, if the economy can drive forward then this should ease some of the ills in this sector.

One area LGIM likes is European telecoms which they think can add value to their offerings.

Emerging Markets

This appears to be an area which is going to benefit from a weaker US dollar. The categorisation of what constitutes an emerging market can be somewhat vague (sometimes includes China). Asian equities look particularly attractive benefitting from the new trade agreement and China’s economic resilience. Valuations are reasonable and a bias towards the tech sector in this part of the world looks attractive.

I think it’s fair to say that there is little love lost between India and China. It was therefore no surprise that India has chosen not to join the other 15 countries in establishing the RCEP. It is a strong indication that India wishes to strengthen its ties with the western world and particularly the UK now its outside the EU trading bloc. Sanjay (LGTV) commented that Indian politics are in a mess, however the biggest democracy in the world has got a lot to offer down the line.

From a valuation standpoint, emerging markets, when adjusted for inflation, are throwing up valuations similar to what was last seen in the late 1990s.

United Kingdom

UK equities lagged the developed world in terms of performance. However, UK smaller companies, despite the Pandemic and Brexit, have performed remarkably well. Sanjay (LGTV) stated that we have some fantastic smaller companies here in the UK and we are arguably second only to the United States.

Larger cap stocks in the form of the FTSE 100, which has a biased towards specific sectors, is export led and has a low exposure to technology, has brought up the rear in terms of performance, despite its surge since the beginning of November last year. However, Sanjay (LGTV) stated that the FTSE 100 is a proxy for global growth via its focus on oil, energy and commodities. Add in some inflation and it is difficult to argue against having an exposure.

LGT Vestra commented that the UK is lagging in its GDP compared to its developed market counterparts, but this does throw up opportunities in the mid cap sector.

Francis Chua (LGIM) doesn’t believe that the UK’s prospects over the long-term warrant a high exposure although he does accept that with the UK having lagged the major markets over the last year, in the short-term, there are opportunities, especially in the mid cap 250-350 space.

Japan

This is not an area we have much exposure to. On the face of it, valuations are very attractive. However, economic growth is weak and the Bank of Japan’s policy does not appear to give them much wriggle room. Their ageing population seems to be a real anchor on economic growth. Despite saying this, Japanese companies are renowned for being well capitalised with strong balance sheets.

Francis (LGIM) stated that they are mildly positive towards Japanese equities because they look attractive on a valuation basis. They have a new Prime Minister, but he doesn’t appear to be as aggressive for reform as his predecessor which in turn Francis believes will slow the potential rate of growth of the economy.

However, this is not to say there are not opportunities, especially on the back of innovation and with such a hi-tech economy there are companies which are deemed very attractive.

In the more traditional space, Francis (LGIM) mentioned that they really like Japanese railway stocks. They deliver a high dividend yield but from a valuation point of view they have lagged. It is their belief that once there is a resumption of stronger economic activity then such stocks should bear fruit.

Bonds/Gilts

On the credit side there does not appear to be much value and therefore our investment partners are seeking alternative solutions wherever possible. The performance of UK government gilts has been disappointing over the last 6 months, posting losses.

The bond market is some ten times the size of the equity market and therefore it’s too much to cover in this communication. Just to give the inclusion in portfolios some context, bonds are used to create a ballast. For example, last March, although bonds did fall in value, they didn’t drop anywhere near like their equity counterparts. They are a steadier form of investment but in the investment arena we find ourselves in, with low interest rates, they are not deemed attractive. Selling too much however, and not having ballast in portfolios, is dangerous.

Corporate bonds have looked much more attractive and the quantitative easing introduced early last year certainly led to a wall of money being invested in this sector. However, corporate bond spreads are tight, and they are no longer offering such good value.

Government bond yields are low and the lower interest rates go, the harder it is to eke out a return. The best performing bonds over the last year were in the US and the UK but they are going to struggle in the immediate future.

It was interesting to hear LGIM’s thoughts on government bonds; they are not looking to sell nor are they looking to buy. Their premise is that at some point, the various stimuli designed to get the economy in a strong recovery mode will create inflation.

LGIM are also seeking to diversify and be creative in delivering stability across their multi-indexed portfolios by seeking alternative assets. They are seeking new ideas to generate yields and like us here at Blue Sky, they have an eye on infrastructure.

Investment partner views

Below is a brief overview from our investment partners. We will deliver more content in future weeks when we discuss various themes. But for now, it is just really a few comments on sentiment:

Sanjay commented that there is a danger that money just keeps pouring into trackers which further inflates the valuations of tech stocks. Whilst tech stocks have continued to perform positively, increasingly there are concerns that the recent volatility is a pre-cursor to something more penal. There are worries about some of these tech giants being broken up and with a new administration ensconced in power at the White House it would suggest that this is a real possibility. However, Biden has a lot on his plate right now and it will likely be some time before this reaches anywhere near the top of his agenda.

LGTV are most definitely positive about equities. However, Sanjay was candid in saying that whilst most elements are pointing to a strong recovery in equities, he is mindful of how quickly news flow and sentiment can change. He also mentioned that he was concerned about how quickly some share prices have responded to the stimuli and now look expensive at this early stage of the economic cycle.

It’s important not to generalise however when using the words ‘investment markets’. Already I have spoken about the wide and varied dynamics between asset classes and economic regions. If we take the healthcare sector as an example, Sanjay commented that Pharma has largely been ignored which has left them undervalued relative to most other parts of the equity market.

The news flow is awful, but Ben Kumar stated that this masks how resilient some parts of the business world have been. The focus in the news has largely been on individuals and those who have been adversely affected by this pandemic and not the success stories.

From a central bank and governmental standpoint, at some point there will be a change in direction and an unwinding of stimulus. Inflation will have risen, and tax hikes will be aggressive. However, in the meantime, equity markets should be the beneficiaries of the desire to get the global economy up off its knees and into action. Ben stated that they believe that mid and smaller cap companies look attractive when looking towards a recovery and this is also the case for the tech sector which is demonstrating some worryingly high valuations, especially with the ‘big five’ in the US.

It’s hard to argue that equity markets now look cheap, yet some part of the markets appear very attractive.

Ben commented on the performance of the healthcare sector. He shares a similar thought process to LGT Vestra. As a whole, healthcare and Pharma specifically, haven’t really participated in the equity rally we’ve seen to date. There were concerns in this sector that it would suffer if Biden obtained the majority in both the Senate and Congress, but the sentiment seems to have shifted, particularly as the rest of the equity market has powered ahead. US healthcare stocks now look significantly undervalued. It is unlikely that Biden will now attack this sector as we are in the midst of a health crisis.

Ben stated that he thinks the recovery will be quick once large swathes of the population have been vaccinated. A beneficial feature and by-product of the crisis is how quickly many businesses have adapted with innovation accelerating at a pace, quicker than it would have been in more normal times. Successful businesses have been nimble.

LGIM believe that we are in the early stages of the new economic cycle and it is small cap holdings which are likely to outperform its large cap counterparts. They also reinforced that the weaker dollar should help emerging markets, particularly in Asia where they are seeing investment orientated towards regions and countries with prospects for strong growth. Whilst not for the faint-hearted, as others have stated, there seems to be a decoupling underway of east and west.

Francis spoke about ‘new world’ investments of artificial intelligence, robotics, e-commerce, sustainability and infrastructure; all areas attracting considerable investments. In the weeks to come I’m going to talk about such themes, picking one specifically each week. So, there will be a lot more to hear from LGIM.

I’m afraid that there is so much to articulate, I’m going to leave much of my discussions with Foresight for next week when the theme of our weekly commentary will be solely on infrastructure.

Biden coming to power and having control of the Senate and Congress is a major step forward in terms of committing to infrastructure. Infrastructure in Foresight terms, involves them investing into physical assets. I was once told by them that if you can’t go into a field and hit it with hammer, we won’t be investing in it. In other words, their investments are backed by something physical as opposed to some conceptual idea floating around the ether. It’s real!

The Foresight Infrastructure funds promise a strong yield (above 4%) which they are confident in delivering as they are investing into well capitalised businesses with largely predictable earnings.

The renewable energy sector is a big part of their approach but particularly on the global stage there are all manner of ways whereby infrastructure can have a positive impact economically and environmentally.

The timing could not be better for infrastructure in many ways. Innovation is happening quickly and there is a need for governments around the world to stimulate their economies by investing capital and creating jobs. This brings opportunities and the performance of the global infrastructure fund to date backs this up!

Summary

As you know, our focus at Blue Sky is very much on themes, but we cannot ignore the geographical and regional influences which dictate where money is allocated.

We have seen a huge shift in dynamics across political and economic landscapes around the world with some huge differentials.

Some sectors of business have been badly hit whereas others are booming. One local IT company I heard about in the last few days, albeit with a global reach, are growing at over 500% per annum!

Thematically we really like technology but increasingly, ourselves and our investment partners, are diversifying into the broader technology arena in the form of artificial intelligence and robotics.

As regular readers of our commentaries know, we are committed to investing into companies which are embracing strong environmental and social governance (ESG) and who are making a positive difference to our environment. This sector of the market is attracting huge inflows and encouragingly, the investment management space is now becoming part of the solution in that it is alienating those companies who are not focusing on their environmental responsibilities. The passion, enthusiasm, and expertise of Phoebe (LGTV) is invaluable here.

Then we have infrastructure. We have worked with Foresight for a few years now and increasingly have been mightily impressed by their level of innovation and expertise. Most of our portfolios now have a good element of infrastructure and its particularly relevant at this time, when governments around the world are committing vast sums towards infrastructure projects. Interestingly, infrastructure and sustainability are interwoven because, of course, those governments awarding contacts to private companies are being held to account and increasingly, are issuing contracts to companies who have strong sustainability credentials.

The overwhelming good news is that, not far around the corner, we should be enjoying better days economically, financially, socially and personally. 

A nod to the strapline on our website if I may:

Change can be daunting but, managed properly, it can be the start of something truly amazing.

Change is happening at a quicker pace than ever due to the pandemic. It doesn’t feel like it at the moment to most of us who are stuck indoors, but there is no doubt that there are some exciting opportunities unfolding.

Finally, a pet subject of mine: the FTSE 100 is NOT the investment markets. It is just one index. A narrow and skewed index at that and because of that, it can be very volatile. There are so many ways to invest with less risk and greater opportunities to achieve better returns and at the same time making a difference to what is happening around you.

Thank you and a big pat on the back if you got this far… don’t worry, commentaries like this are only every 3 months!

Gary and the Blue Sky Investment Team

Risk warning

Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.