Let’s Get Cyclical, Cyclical
John Leiper – Chief Investment Officer – 18th September 2020
The following is an abbreviated version of my recent article ‘A Deep Dive Into… UK Equities’ for Investment Week magazine. Follow the link and read my views on page 17.
UK equities are deeply unloved, suffering as they do from a confluence of factors including a weak domestic economy, poor handling of the coronavirus and ongoing anxiety over Brexit. This is reflected in the relative underperformance of UK equities versus developed market peers.
With a looming October deadline, the next catalyst is Brexit and whilst near-term negotiations are likely to get worse before they get better, we continue to believe a deal will eventually be reached. If that is your base case, there is clear upside to UK equities although investors will need cast iron conviction and a strong stomach to navigate the interim volatility.
The rebound in global equities, outside the UK, has been led by the US but market breadth is thin and most of the gains have been driven by a narrow group of global technology companies whose business model is particularly suited to the coronavirus. Instead, UK equities are largely geared to value and cyclical stocks with energy, financials, industrials and materials accounting for approximately half of the FTSE 350. These sectors have fallen out of favour for a variety of reasons including dividend cuts, falling energy prices and a broader structural shift towards ‘ESG’. They also do best in a reflationary world when interest rates are rising.
Higher rates are a distant prospect, but the Fed’s announcement that it was shifting to average-inflation-targeting, felt like a key moment. As a result, Powell’s speech could be seen as the klaxon for a new phase in the global macroeconomic cycle. If this coincides with an improving economic outlook, then we could see a significant rotation within equity markets towards value/cyclical sectors, which could work to the benefit of laggards like the UK.
The return of inflation should benefit real assets such as commodities, which I see as a UK play. Commodities have performed very well recently as demonstrated by iron ore prices which allowed Rio Tinto to return $2.5 billion to shareholders, making it one of the UK’s biggest dividend payers. Whilst this is an extreme example, investors are likely too pessimistic on forecast dividend cuts, as we saw in swap markets following the subprime mortgage crisis in 2008.
Currency is another factor. The FTSE 100 is dominated by multinational companies which derive the majority of their revenue overseas, meaning when the pound is strong it acts as a headwind to profits. Setting aside near-term volatility, we think the US dollar can depreciate as much as 20% over the coming years. If sustained, a strong pound is bad news for UK equities and the economy, as it tries to establish an independent future outside the EU.
To summarise, UK equities are attractively valued and should benefit from a deal on Brexit, a rebound from overly pessimistic dividend expectations and a rotation toward cyclical/value based sectors following a noticeable improvement in the economic outlook. However, considerable uncertainty remains and at this juncture the risk to reward ratio is simply better elsewhere.
This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.
Want to know more about the Equity Markets?
Please contact us here:
Q2 2021 Quarterly Perspectives
Welcome to the Q2-2021 ‘Quarterly Perspectives’ publication
Rise of the Underdog
In its latest economic outlook, the OECD increased its expectations for global GDP. For 2020, the improvement is minimal, reflecting an upward revision, in real GDP, from -4.5% to -4.2%. But beyond that, growing economic momentum should boost global growth to pre-pandemic levels, estimated at 4.2% in 2021 and 3.7% in 2022.
Let the Good Times Roll
Markets are ebullient, and they have every reason to be.
Nothing Is More Powerful Than an Idea Whose Time Has Come
On Monday afternoon, global stock markets soared on the news BioNTech and Pfizer had created a coronavirus vaccine which proved 90% effective based on initial trial results. The story behind the breakthrough, which you can read here, is fascinating, not least because the husband and wife team behind the virus don’t yet know why it works.
Anatomy of an Election (So far…)
The narrative, heading into the US election, was a ‘Blue Wave’ victory for the Democrats. Polls and betting odds favoured a Biden win and a Senate majority and investors positioned accordingly. Anticipation for a huge fiscal stimulus package, estimated at $3 trillion+, lent itself to the global reflation trade which would stimulate the economy and revive inflation, benefiting cyclical assets whilst hitting government bonds.
Since the Market Low
The ACUMEN Portfolios continued their strong run throughout October, largely outperforming the market composite benchmark and IA sectors (used for peer group comparison purposes) which lost ground across the board.
Canary in the Vol-Mine
With the US election just 8 days away, financial markets are following the polls and pricing in a Biden win. The prospect for a Democratic clean sweep has contributed to the rising ‘Blue Wave’ narrative benefiting those companies that stand to benefit from Democratic party policy. Meanwhile a long/short basket of companies more closely aligned with Republican policy and values has steadily underperform.
Q4-2020 Quarterly perspectives
Welcome to the Q4-2020 ‘Quarterly Perspectives’ publication.
Further For Longer
On Tuesday Fed Chairman, Jerome Powell, made a speech at the National Association for Business Economics, during which he implied the government should err on the side of caution and provide too much stimulus rather than too little.
Life Imitating Art
Saturday Night Live has a reputation for expertly parodying presidential election debates. My all-time favourite is Al Gore (Darrell Hammond) versus George Bush (Will Ferrell) and this year didn’t disappoint with expert performances from Donald Trump (Alec Baldwin) and Joe Biden (Jim Carrey).
Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.
In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.
The NASDAQ Whale
The ACUMEN Portfolios continue to perform well. As you can see from the table below, performance for the rolling quarter (to the end of August) remains strong relative to the market composite benchmark and the current assigned IA sector, which I understand many advisers use for comparison purposes. ACUMEN Portfolios 3-8 were all in the first quartile and ranked in the top 15 within their category.
A Speech For The History Books
In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’. This means the Fed will now allow inflation to overshoot its official 2% target to compensate for prior years where inflation failed to reach that level.
Room to Run
Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.
In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.
A Currency For All Seasons
Having identified, and benefited from, the 7% fall in the value of the US dollar index since late April, we have now turned tactically cautious.
All That Glitters…
In last week’s blog, This Time It’s Different (24 July 2020), I suggested the US dollar was on the cusp of crashing through its decade-long uptrend.
This Time It’s Different
There are growing signs that the US dollar may finally roll over.
Q3 2020 Quarterly Perspectives
Welcome to the Q3-2020 ‘Quarterly Perspectives’ publication.
Commodities Move Higher
The 10 year US Treasury yield has remained remarkably steady over the last few months, particularly as inflation expectations have gradually risen.
The Bigger They Are, The Harder They Fall
Those stocks that outperformed during the corona crisis are the same ‘winners’ that outperformed before the crisis.
Pivot to ESG
The recovery in US equity prices, from the corona crisis, has been one of the most rapid in history.
The Chinese Tech Structural Growth Story
China’s economy has transitioned, from an industrial export-led model, towards services.
The Commodity Carve-Out
Commodities are nothing if not cyclical. They rise and fall in value with remarkable consistency over time.
The Return of Inflation
Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.
The Powell Pivot 2.0
In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.
Don’t Fight The Fed
Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.
The Liquidity Crisis Is Dead. All Hail the Solvency Crisis.
In response to the corona crisis, global central banks have unleashed a tidal wave of liquidity.
Economy ≠ Markets
One question I get from advisers and clients, more than any other, is why global equity markets have bounced back so far.
From Liquidity To Solvency
In the early stages of the Corona Crisis of 2020, the global economy faced a liquidity crisis.
In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.
FT Adviser – 16 April 2020
In a trading update last week, the listed adviser warned that the outbreak has caused commercials conditions to become “extremely challenging”
FT Adviser – 16 April 2020
Bosses at Tavistock Investments have taken a voluntary, significant pay cut…
One Currency To Rule Them All
As the world’s reserve currency, the US dollar is the go-to currency. It is used to price assets, complete transactions and as a store of value.
Proactive Investor Interview – 8 April 2020
Brian Raven tells Proactive Investor its two protected UCITS trusts have proved themselves during the current market volatility caused by the coronavirus pandemic.
The beginning of the end?
The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.
Return-of-capital is as important as the return-on-capital
Last week, we considered the debt story behind the coronavirus. The fear of a large debt overhang, as the economy slows, led to concern that households and companies could start to default on their...
Market Notes 23rd March 2020
In the past three weeks, global equity markets have fallen almost as much as in the Financial Crisis of 2007-08.
Fund veteran takes major stake in consolidator in UK wealth plan
Investment sector veteran Hugh Simon has taken a near 5% stake in wealth consolidator Tavistock in a strategic partnership.
Market Commentary – March 2020
In the past week, global equity markets have fallen again and yields on developed market government bonds have collapsed even further.
Halcyon days, global equity markets have fallen again and yields on developed market government bonds have collapsed even further.