Please find below our interim Investment Market Update as at 26th February 2021.
Blue Sky Investment Market Update
What a difference a week makes!
Certainly on the global stage where stocks and bonds have experienced a sudden surge of volatility. I was going to write about our final theme today, but I think that is for another day as it’s important to articulate what has been going on.
The pound rises
On face value, this is good news but for overseas assets that are unhedged this is not such good news.
The pound has risen strongly. On 1st November last year, the pound vs the euro was at 1.11 and, just days ago, it had risen to 1.17 but has since fallen back to 1.14. The pound vs the dollar on 1st November was 1.29 but recently reached a height of 1.42. It now stands at 1.39.
The main reason for the recent rise in the value of the pound is because the UK is leading the way on vaccinations and our economy is to be one of the first developed counties to pick up and demonstrate good recovery figures.
With our assets being denominated in sterling, then a rise in its value means that when stocks in Europe and in the US are translated into pounds there is some weakness at play.
Why not all UK stocks then?
A piece from Bloomberg states that “UK assets are currently riding high. The pound is the best performer so far this year of the 16 major currencies versus the dollar. Against the euro, sterling is enjoying its best winning streak since 2015 with nine consecutive days of gains. And, for a change, it’s not just dollar weakness boosting the pound. Against a basket of currencies of Britain’s major trading partners, the pound has reached its highest level since December 2019, after concerns about how badly the Brexit negotiations were going”.
I’ve written many times about how the UK has underperformed the main equity indices compared with our developed nation counterparts. In one of my updates just before Christmas, I highlighted that we may move some more assets into the UK, mainly because we felt it was undervalued. We subsequently increased our UK exposure across our in-house portfolios.
Naturally, we have also been wary of the Brexit impact which, as yet, is still unknown and certainly we didn’t expect the pound to strengthen so significantly in such a short time frame. As usual, there are many forces at play here.
We are not going to chase the UK growth story and rotate more assets into the UK. We believe in a strong recovery, but it is fair to say that other countries will deliver their vaccine programme and then we could possibly see the pound weaken against other currencies or certainly stabilise. For now, the rise in sterling has impacted portfolios in the short-term, especially those with an international feel.
Again, reported in Bloomberg; “While UK assets are currently in vogue, investors allocate money on a relative basis. And as my colleague Therese Raphael argued a few weeks ago, many of the contributing factors to the UK’s vaccination success are replicable elsewhere. Many countries will hopefully catch up with Britain sooner rather than later”.
Global Infrastructure and Sustainable have been affected
It is somewhat ironic that both sectors have struggled over the last 10 days or so. I say this having recently written about them as two of our favoured themes. Robotics and artificial intelligence have also suffered some collateral damage.
An added complication is the extreme adverse weather that has been experienced in Texas. The wind turbines which account for a good 20% or so of the energy being fed into the National Grid appear to have failed. This caused a significant pull-back in the value of some renewable energy stocks.
However, it is also fair to point out that gas supplies into the grid also failed and this accounts for more than twice the output to that of wind power.
I mentioned to someone yesterday that when the Concordia sank, the cruise line industry had a short-term drop in customers and share prices of cruise liners fell quite steeply, yet sentiment quickly changed and up until the pandemic, the cruise line industry was roaring. We expected to see some pull-back in renewable energy prices following what happened in Texas and, in our opinion and that of Foresight regarding their Global Infrastructure Fund, this presents a good entry point into some stocks which may have previously looked pricey. This is exactly what Foresight have done. However, it is worth pointing out that Foresight’s top holdings in this fund are not in the renewable space.
Optimism hits equity markets!
The S&P 500 (US) has fallen by 2.49% over the last 5 days whilst the FTSE 100 has risen by 0.74% at the time of writing. Whilst there may be an uptick in optimism in the UK due to the vaccine roll out, ironically when it comes to the US, markets are worried there is too much optimism!
Let me explain.
You may remember me writing a piece about the Great Depression and one of the big problems in the US back then was deflation. This pandemic threatened to potentially take us into a tailspin of deflation which certainly was not desirable. The huge stimulus packages from central banks and governments ensured this didn’t happen. We had periods where the economy was treading water but now, we have the prospect of inflation rising strongly as a recovery gets underway.
Nothing wrong with rising inflation but with the vaccines arriving earlier than expected, equity prices probably rose a bit too quickly. This should not be interpreted as us not favouring equities but a pullback in prices, strategically, is good news although it doesn’t feel like it when you look at your valuations at the moment.
Bond markets wobble
Yesterday we saw the most turbulent day in the bond market since the lockdown last March. US Treasuries (government bonds) were described in the FT as being at the centre of a fierce rout.
“Yesterday proved to be nothing short of a rout in global markets, with the sell-off in sovereign bonds accelerating as investors looked forward to the prospect of a strengthening economy over the coming months,” said Jim Reid, research strategist at Deutsche Bank. The tumult in the bond market ricocheted into Wall Street stocks on Thursday, sending the Nasdaq Composite sinking 3.5%, in a trend that spilled into European and Asian trading on Friday.
The attraction of bonds wains when stronger growth and inflation are expected as bonds typically pay fixed interest payments. Across our portfolios we have already manoeuvred as much as possible away from government bonds.
Tightening monetary policies
The equity volatility came as concerns grew among investors that the worldwide economic recovery from the Covid-19 pandemic could generate inflationary pressures, causing the US and other central banks to tighten monetary policies. In the FT it was reported “with the US economic outlook boosted by pandemic improvement, vaccine distribution and the prospects of President Biden’s fiscal package getting through the Congress, investors are now fixated on the risk of inflation and economic overheating,” said Tai Hui, chief Asia market strategist at JPMorgan Asset Management.
Just months ago, we could have only wished for the current dynamic when there were fears over deflation and possible stagflation (no growth).
Investment markets never go up in straight lines!
Since April 2020 we have enjoyed a strong recovery in equity prices, and it is no surprise that we have had a pullback in asset prices. This is healthy and normal. Investors have pretty much got used to a one-way ticket from last April but in recent communications we warned of possible volatility because the recovery had been compressed into a narrow time frame for what is deemed a new economic cycle.
Stock markets certainly don’t go up in straight lines and falls of 5-10% are quite normal. Of course, if you have a balanced fund then typically the variance is lower but it’s been compounded by the rising pound and the short-term correction in renewables.
An article in Bloomberg yesterday suggested that this recent volatility bodes well for equity prices.
The market’s so-called fear gauge is elevated, and that could bode well for stocks if history is a guide. “The spread between the VIX (measure of volatility) and two-week S&P 500 realised volatility, has widened to a point that historically has been followed by a volatility decline and stocks on average moving higher”, JPMorgan Chase & Co. strategists Marko Kolanovic and Bram Kaplan wrote in a note Wednesday. “Historically, three months after the spread moved this wide, the VIX fell 11 points and the market rallied an average 12% with a move higher 87% of the time”, they said.
Whilst the above appears a tad technical, what it is saying is that for new money this is likely to be a very attractive entry point and for existing investors the key is to sit tight, and a resurgence is likely. Lots of forces have been at play over these last few days. Remember, it is normal to have a pull-back after periods of strong growth. Like a pressure cooker, some steam has been released but we keep on cooking!
Have a lovely evening and weekend.
Gary and the Investment Team
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.