Please find below our Investment Market Update as at 7th January 2022.
Blue Sky Investment Market Update
Turmoil in the first week
A Happy New Year to you all. I hope you managed to make the most of the festivities and the New Year celebrations. A quiet one for many, I’m sure!
The investment markets haven’t started off quietly! After positive momentum over the holiday, albeit with weak trading volumes, equities have been halted in their tracks with much conjecture about what the economic and corporate landscape will look like as the year unfolds.
What are the main considerations?
- Interest rates and the extent of rate hikes
- Inflation – how transitory will it be?
- Supply chain issues
- Omicron and other variants
I’m not going to look at these one by one because this has been covered off in our previous Market Updates. However, it’s worth spending some time looking at interest rates as rhetoric has now turned into action.
Prior to the rate rises, the investment markets were worrying about inflation running out of control. Whilst there are still concerns about this being elevated, the general view is that this is most certainly transitory. Raising interest rates is a tool which Central Banks use to control inflation. The Fed has indicated that there will likely be three hikes in interest rates this year, but recent reports have spooked equities by suggesting the possibility of rates rising more aggressively.
Here are some comments from the investment press.
Katie Martin in her article points to more volatility ahead. “The only certainty for 2022 is that there is likely to be more uncertainty in the markets”. We could say this for every year of course, but it does appear that the unwinding of monetary stimulus is likely to be a messy process.
Equity and real estate markets are high in many countries, as is public and corporate debt. The Swiss Central Bank recently commented that this combination makes financial markets more susceptible to shocks. This is likely to manifest in lower across the board returns than in the last 18 months, although there are still some great opportunities.
By way of context, the S&P 500 index of blue chip US stocks had only dropped more than 2% in a day on just five occasions in the whole of 2021 despite all the Covid-19 drama. The emergence of the Omicron variant left barely a mark on the markets after a couple of days had passed. Things are likely to be different this year.
However, I said to a potential client only yesterday, we are still expecting good returns from equities, but it will pay to be nimble and use corrections/pull-backs as opportunities whilst being selective as to where money is deployed. Blanket returns are unlikely!
Rising inflation and interest rates are not good for bonds but there will be opportunities as rotations and sentiment changes. It was interesting to listen to Phoebe Stone yesterday, a partner at LGT Vestra, when she commentated that they expect to be far more active trading bonds than in equities this year. This is not to say they favour bonds over equities, just that there will be opportunities to create value in portfolios.
Goldman think bond buyers face a “new conundrum” where Treasury yields will stay low even as the Fed tightens, despite the surge so far this year.
In another FT article on Wednesday, responding to the drop in equities in the US, particularly the Nasdaq (technology), it highlighted how investors/traders dumped shares in many technology companies that havepreviously surged during the pandemic. The likelihood of higher interest rates prompted a move towards businesses more tightly linked to the economic recovery. The Nasdaq closed down 3.3% on Wednesday, its worst day since February 2021!
At the same time, the sell-off in US Treasuries intensified. With yields on government debt rising, the appeal of many unprofitable companies has been knocked. Their valuations are dependent on potential earnings in the future and therefore are sensitive to rising interest rates. The rotation has favoured large industrial companies and banks, the latter responding to interest rate expectations.
Particularly vulnerable are what are called Spec-tech companies, referring to speculative unprofitable technology companies with high valuations, something which we at Blue Sky generally steer clear of by the way, although in our Momentum Portfolio we do have an exposure to Robotics and Artificial Intelligence. However, our exposure is very much focused on companies that generate earnings and have strong balance sheets.
It’s important here to separate speculative technology from mainstream technology. After such steep gains it is to be expected that periodically there will be pull-backs and profit taking. According to Morgan Stanley, the sell-off in what they call hyper expensive tech shares, has almost petered out if past shocks are a guide.
What is attractive?
Europe and the UK
According to Goldman Sachs Group, as reported in Bloomberg, European equities are a good place to shelter. Last year across two of our Blue Sky portfolios, we increased our European holdings. Strategists, led by Sharon Bell, wrote that rising rates should favour European equities, as they have less rate sensitive sectors across their main indices. Europe, like the UK, differs from the US in that valuations don’t look particularly stretched versus past multiples.
It would appear that the scales are now tipping in favour of Europe having consistently underperformed the US. In previous posts I have commented on fiscal (tax) policy and spending which is expected to expand, in contrast to the US where fiscal support is predicted to weaken. Goldman recommend European banks, energy stocks and single out healthcare as their preferred cheap growth area.
Citi Group also favour European financials as well as broader UK equities which are closely tied to the recovery and where companies can pass on price increases.
The last couple of years or so have dispelled the myth that when investing into ethical areas one has to compromise on performance. Quite the opposite in fact.
Regulation is fast coming down the tracks for medium and smaller sized companies, having already impacted many larger corporations. Consumers are now becoming more aware and demand to know more about the Sustainable credentials and supply chains of companies they are buying from. Despite the success of this sector, we are firm believers that this really is just the start of the momentum.
It was great to hear today that LGT Vestra in their quest to be Net Zero, have announced a partnership with a company called Clime Works which build machines designed to take carbon from the atmosphere. This is the first scalable example of extraction. The carbon is stored in underground rock strata.
I think it’s fair to say that Biden has demonstrated a huge commitment towards infrastructure projects in the US. The ‘Build Back Better’ act is waiting to be passed through the Senate and whilst it has some hurdles there is no doubt to many, how important this is. It’s an opportunity to stimulate jobs, the economy, upgrade, repair and innovate after many years of neglect. The same can be said here in the UK after years of austerity.
At first glance this appears a proxy for generalist global growth and in some cases, this is true where companies have simply changed the names of their funds to be more ‘on message’. We have seen this in the sustainable space also. However, what we are seeking at Blue Sky is a real focus on themes which are expected to be at the forefront of innovation and subsequently spending by governments and business.
Below are some of the areas we like:
- Water and waste management
- Biotechnology and diagnostics
- Healthcare innovation
- Artificial intelligence and Robotics
- Changing demographics
- Climate change dynamics
- Resource scarcity
- Timber and forestry…
To name but a few!
Thematic investing focuses on predicted long-term trends rather than specific companies or sectors, enabling investors to access structural shifts that can change an entire industry and subsequently earnings (BlackRock).
Thematic portfolios focus on the long-term allowing investors an exposure to positive transformational change. The world is changing quickly, and we want to be a part of it!
We can’t ignore the US!
It was interesting to hear Phoebe from LGT Vestra reiterate their commitment to the US when stating that there they are still overweight across their portfolios. Rationalising that despite high valuations, we can’t ignore that the US is home to many innovative businesses with potential for real exciting growth. Many businesses have strong growth revenues, the ability to generate healthy margins and are able to pass on costs.
- It will pay to be even more selective this year
- Expect more mini cycles and rotations than last year
- Volatility will be heightened
- Opportunities will be plentiful
- Follow the money: stimulus and spending
- Focus on companies with strong balance sheets and ones which can benefit from the recovery and who can pass on increased costs
- Don’t be constrained by geography but continue to embrace themes fuelled by innovation.
Lighter for longer this month apparently! Let’s hope this continues to be the case for equities too.
Gary Neild 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.