2020 Overview and Global Outlook for 2021

Seasons Greetings to you and yours.

2020 Overview and Global Outlook for 2021

(A lengthy read but you’ll have the time to digest the detail!)

As 2020 closes (what a year it has been!)  we wanted to provide a further Christmas and New Year message wishing the very best of health, happiness and prosperity (using the advice and transactional service and products of BPFS) to you and your wider families!

2020 – Hindsight

2020 will certainly be a yea for the record books….  A Global health crisis and an investment market rollercoaster rise from top to bottom and to the present position like none before.

A Global Trade War, Brexit and a Global Health crisis formed the backdrop which in the main part, remains today – but it seems to be that we are now ‘in the tunnel’ and may soon see the light.

The importance of professional expert advice

Asset allocation and risk balance – delivering beyond expectation has again been delivered this past year.

We have delivered exceptional investment outcomes to our investors as we have selected the best quality assets to fit into the Risk Models (2 – 10 and the new Best Ideas Equity Portfolio) in a truly agnostic way.

We have held the sectors that have delivered and held the winning sectors and funds in the appropriate balance with our clients’ objectives and risk views front and centre to our decision making.  (The ‘facts’ clarify this position when portfolios are measured against relative benchmarks and peer group asset portfolio results).

Key to delivering suitable outcomes has been our visibility and client/customer communication and the effort to carry out periodic reviews during the early summer.

We very much hope that we were able to provide a level of calm and support, against what was an extremely nasty backdrop, with no clear way out of the crisis at that point in time.

Brexit dominated the start of the year – following the Conservative election win – where after years of ‘going nowhere’ it seemed that leaving with an ‘oven baked’ deal was about to happen.

The position remains that ‘horse trading’ continues to this day and a ‘deal’ to leave has yet to be concluded.  We must hope that against the backdrop of the strained economy and current lockdown – with the UK expected to move to Tier 4, a deal will be concluded!  (A more detailed overview is provided further in this communication)

Fiscal and Monetary Stimulus

The Treasury and Central Banks acted to preserve the economy, although there has been a clear disconnect between the ‘real economy’ and the investment markets.

With interest rates at near zero and negative in some developed economies, along with the Bond Buying programmes and various Furlough and PPP Schemes, the Stock Market had ‘looked through’ the here and now and looked to the vaccine and a new normal.  This is evidenced by the strong bounce when the initial efficacy vaccine results were released.

The various stimuli provides a decent backdrop for risk assets for the period ahead, assuming the vaccine is as effective against the virus as the programme of review expresses.

We will see volatility remain (Covid data dependent) although the backdrop is positioned for equity risk growth over the medium term – resetting the cycle.

PE re-ratings could also become a factor in the coming year so we stress to investors to consider their wants and needs and cashflow requirements and deploy capital in accordance with their needs for the medium term.

A well written and well presented document from Quilter Investors is a must read – “Our 2021 Global Outlook” – Quilters’ View, which summarises the winners and losers of lockdown.  Click the link to read the document: https://view.pagetiger.com/global-outlook-2021/qi

A summary of the ‘2020; year – with rational ideas and investment logical positioning

We talk to the leading Fund Managers across the globe so a summary of the ideas and rationale is expressed in this note.  (We must state that this note and details within do not constitute regulated investment advice – professional advice is always specific to the needs of the investor).

UK – Specifically Brexit related;  A conclusion and ‘deal’ is yet to be agreed

Negotiations have been going on all year and horse trading is around the same three issues – Level playing field (state aid/regulations), Enforcement and Fisheries. 95% of the trade agreement is said to be done and written up by the lawyers.
 
Over the last two years the UK have steadily downgraded their expectations on what is achievable as they look to focus on sovereignty over free trade. This means services is largely off the table and instead the focus is on reducing tariffs on goods (Canada trade deal).  Hence we may have a hard Brexit ahead of us and a view that the ‘deal’ if we get one will be ‘thin/skinny’
 
We are now moving towards the final, final deadline to agree and ratify a deal ahead of the 31^st of December. We would expect that if there is to be a deal it would be agreed in the next couple of days.
 
There is intense pressure is on both sides to do a ‘deal’ to minimise disruption to economies which are already battling with COVID. On top of this Boris needs a ‘win’ given falling poll ratings and hard to see he would want to go into a Scottish election next year having delivered no deal. In addition Biden win has removed hopes of a pivot to the US as due to Irish links he will want an EU/UK deal before contemplating a UK/US deal.
 
The probability of a deal is suggested to be 50/50. There will be many headlines ahead of any agreement as each side tries to position the final result as a win. We think the removal of the ‘no-deal’ risk will see domestic stocks perform well and allow international investors to re-visit the UK. The reality is it will take at least 6 months and probably 2-3 years to see what the economic impact of our new relationship is. In the short term when Covid restrictions are lifted will have a far bigger impact on GDP in H1 2020.
 
In the event of a no deal we would imagine a initial knee jerk panic, coming through as the EU themselves have said they will do short term sector by sector deals that help them (rather than us!). But again in this scenario we have ended the uncertainty as we now know the UK will have left the EU on WTO terms and investors can take a view on what that means and likelihood of signing new deals.

If a ‘deal’ is concluded, the UK should deliver and start to clawback some of the underperformance over the last 4/5 years.
 
US – Specifically Election based following the results

The outlook post-election is constructive for Smaller companies as it looks like the Democrats won’t get majority in the Senate meaning that they won’t be able to implement all of the announced policies. Specifically an increase in the corporate tax rate that would have been a headwind for Smaller Companies. There are still some run off elections in Georgia so the final outcome will only be known in January but it looks likely that the seats will be won by Republicans???

For regional banks, outside of the political concerns, they are also faced with large IT spending costs due to the need for digitalisation. This is unlikely to change.
One of the expected change in tone from the Administration is on Green Energy so there might be some opportunities in this growing sector.

Generally we are positive on the small cap space as they are more geared to the domestic economy and therefore will benefit from the US economic recovery.  We hold the leading funds in the sector and are hopeful that Healthcare will be seen as a positive although Tech and Faang are likely to suffer increased governance.
 
Global View

Most people have heaved sighs of relief over the past few weeks. A new US president and impressive vaccine tests surely change the global economic picture.

Donald Trump may have presided over a period of healthy growth, fueled by tax cuts, but he also created unnecessary turbulence. For the past four years, global equity managers have been waking up to his overnight tweets — usually provocative, often incomprehensible — wondering what they might mean for portfolios.

It will be a blessing to have someone in the White House who has actually spent some time in China.  Mr Trump did not help successful businesses with good products to sell around the world. Most boards on these large companies — even if on the political right — will feel it makes planning much easier. They can make decisions without having unexpected rule changes suddenly imposed on them. Expect investment to be unleashed.

The failure of a blue wave to materialise may also be good for markets.  No longer are markets anticipating hefty tax rises in the US.

So where does this leave portfolios?

Times of change are times of opportunity, but also risk. A common mistake many investors make is to put too much faith in the power of mean reversion. They hold on to failing stocks, trusting that they will inevitably recover. Unfortunately, a Covid-19 vaccine may fill them with misplaced optimism.

At times of such significant societal change some business models become outdated and will never recover. Work arrangements will probably become more normal next year but how many of us will ever return to the office full time?

Many restaurants, bars and sandwich bars in London’s financial centre will close permanently and landlords will struggle to re-let. Fewer people spending time in city centres will further damage high street retail. Offices will become smaller, driving down commercial property prices. Where offices remain open, owners will have to upgrade them.

The lift industry…

Some companies which have performed well this year will continue to benefit. One area in the ascendancy — pardon the pun — is the lift industry. It is dominated by four companies: Fujitec (Japanese), Kone (Finnish), Otis (American) and Schindler (Swiss). The bulk of their profits come from maintenance, so there is attractive recurring income.

In July it was claimed that one Chinese woman, returning home to quarantine, passed the virus on to 71 others in her apartment block through a single lift journey. Not surprisingly, lift companies are busy making adaptations to address Covid concerns. Kone has developed an app that allows you to call for a lift with your mobile phone to reduce touch points.

A vaccine is unlikely to reverse this wave of upgrades — the world must be prepared for more pandemics. Lift companies also benefit from the powerful European green agenda. This is especially the case in France, which has the oldest fleet of elevators in the world. There is a drive to replace its rattling fin de siècle wrought iron contraptions with modern lifts that are energy efficient.

A low-carbon economy…

The US now looks set to adopt Europe’s climate change agenda. Though it only formally withdrew from the Paris climate deal last week, Joe Biden has already set in process an executive order to take the US back in. The president-elect promised voters he would spend $1.7tn on the transition to a low-carbon economy.

A quarter of the world’s total carbon emissions come from heating and cooling buildings and transporting refrigerated goods. Regulations are likely across the world — and not just in the US — to reduce the energy demands powering this infrastructure.  Trane in the US and Daikin in Japan offer opportunity. Both have seen increased orders for systems that clean office air more frequently and use less energy.

Software providers…

Many asset managers like software providers, including Salesforce.com, Accenture and ServiceNow. The latter two offer complete outsourced IT support packages, including cyber security and the cloud. It seems likely that demand for such services will remain high for some years.

Healthcare…

Perhaps surprisingly, the healthcare sector has not performed as well as it should, given the backdrop.  Markets were concerned that a large swing towards the Democratic party in the US elections would lead to pressures on profits for healthcare providers. This now seems unlikely and we expect these shares to perform better next year, especially as much delayed elective surgery will now be scheduled.

We have seen how rapidly new diseases can become global pandemics, so developed societies must surely invest in hospital capacity and testing ahead of future outbreaks. This should benefit companies at the forefront of medical testing in particular.  Liked are Thermo Fisher and Becton Dickinson, which will benefit from a recovery in surgery activity.

In summary…

Other sectors may now pause a beat. Obvious “working from home” stocks, including Amazon and Netflix, have been some of the biggest beneficiaries of the pandemic and their share prices have risen sharply. Perhaps too sharply.  You may have noticed how all of the companies mentioned here are international — from the US, Europe and Japan. A global portfolio of well-researched companies continues to steady the ship. It is hoped that the news of the past week means that the swell has calmed for some time.  Being globally diversified is essential.
 
5 reasons why value rotation could continue

Investors have fallen for the Value vs Growth trade several times over the past year and each episode has left them punished ultimately so reluctance is understandable . More vaccines and better therapeutics likely are coming, allowing for some return to a semblance of normal.  The IT sector and related businesses accounted for more than 35% of the S&P 500 constituency and such lopsided weights have never lasted in the past.  The potential for higher inflation expectations also signals a plausible swing towards cyclicals.
 
5 reason +  why value rotation could have legs:
 
Unique environment of dividend yields exceeding 10 year Treasury yields (Fig 2) suggest that investors might need to focus more on the income component which benefits certain stocks more than others (usually more in value camp).

Lead indicator (Fig 3) is favouring value
Valuation (while not TMT bubblesque) still above average for growth
The tech sector’s weight within the S&P is nearly equivalent to levels experienced in 1Q00 and does not even include some names in Internet Retailing / Media & Ent. 35% weight fa exceeds Energy in the late 1970s or Financials in 2007 when they peaked à hence questioning the sustainability seems prudent
Lower rates support higher P/Es but risk premiums also matter
The latest C&I lending standard data show improving conditions which should be +ve for 3Q21 as it has a 9 months lead on industrial production and capex usually benefits cyclicals vs defensives.

Charts provided by Artemis Funds:

Brexit – Is a deal priced in? No! Asymmetric risk embeds cautious positioning

There has been a lot of conversation about Brexit trade deal this week. Consensus remains that a deal will be struck but the absence of a definite cliff edge deadline creates slippage in the timetable. That firm, consensual belief in Deal creates an issue regarding the likely market response. Many perceive that because a trade deal is 80-90-% likely in their personal estimation , it is similarly ‘priced-in’ to equity markets.  In fact the degree of asymmetry in the perceived risk defines the positioning – and upside…

A) There are lots of hedges in place in the real world on £ sterling. Wouldn’t you hedge just in case if you ran a business with $ revenues ? The removal of these hedges will give £ a boost and by association drive the domestic basket.

B) Managers are still seeing hedging long UK domestic equity positions with derivatives. As the ‘event risk’ in UK assets is passed so the elevated volatility on these contracts will fall. This causes the banks on the other side of these client hedging contracts to buy the underlying Brexit basket as their ‘Delta Hedge’ is commensurately smaller. This is the same phenomenon as we saw in S&P when VIX dropped after a) the US General election and b) the vaccine news.

C) The asymmetric perception has been the cause of the 4.5 years buyers strike from Intl investors in UK assets. No-one wants to be the person who bought £ assets just before Hard Brexit…Ownership of UK equities is at the all time lows in key competitor positioning surveys.

D) Many cautious long only investors were caught out in 2016 pre-empting the binary outcome of the Referendum . They do not want to position pre-event. ‘If I take a big bet now I am betting my career because the downside is so large. After a deal I can invest even if the shares are +10% because the risk-reward is transformed. There is no longer the massive downside from NO Deal. The risk-reward is totally transformed… ‘

E) As we have seen before, the indifference curve of many long only investors is very risk averse. Their price elasticity of safety is high.  Generically these investors would much rather pay x13 for a company with the debt risk eliminated than x10 for the same company with an open question about debt. The same applies here for Hard Brexit risk . UK long only will definitely ‘pay (much) more, to see more…’

Finally, there seems to be an emerging view that a trade deal is BAD news for domestic stocks because it will be skinny and disadvantage the UK for years to come. This is undoubtedly true. But the evidence won’t be empirically visible in macro data for a year or more. There will be individual issues and friction with the transition for sure. But this group of stocks has underperformed the global index by -50% over 4.5 years. Therefore -0.5%pa off the the long term GDP growth vector is way less important than the instant cathartic release of eliminating Hard Brexit risk…

In fact a skinny deal IS priced in. The final removal of No Deal risk is not.

Below is a Brexit Basket constituents ranked by performance since the low for sterling and relative low for this basket against the market on 23rd Sept. The Value v Quality theme within this basket is another reason that pure Sovereign UK identity has not been material in moving stocks. The Brexit Basket is +30% and the All share Index is +11% during this same period for reference.

The data above measures the results of the Brexit Basket against the All Share, expressing why professional expert ‘input’ adds value.

We are yet to see the Santa Rally develop, as the new flow has been troublesome – so let’s hope that the seasonal cheer takes over soon – maybe moving to 2021.

We would once again wish all of our clients and customers the merriest of Christmases and a 2021 that is the Happiest yet…

Remaining positive has been essential, we will hopefully see the fruits of staying the course and we look forward to seeing you face to face on the ‘other side’.

Compliments of the Season and best of health.  We are your friends and here to help and support, along with being your Trusted Professional Adviser.

Richard and the Best Price FS Team