Investment Outlook - 9th February 2021A fortnightly look at global financial markets
By Tom Elliott - International Investment Strategist, deVere Group
-
- Investors remain pro-risk
- Trump’s shadow remains divisive
- Valuations support equities
- Reddit/ GamesStop – a new price insensitive investor
- Brexit and sterling: the Irish border question just won’t go away
Market sentiment:
Remaining positive. Investors continue to have confidence in the vaccine roll-out programs of the developed economies, with strong demand growth expected from the third quarter onwards. Economists support this optimism, in late January the IMF upgraded its 2021 world GDP growth estimate by 0.3% to +5.5% (from -3.5% GDP growth in 2020).
Critical to this scenario are two things: the continuation of loose monetary and fiscal policies around the world,
but especially in the U.S, and the success of the vaccine program in face of mutations of the virus, anti-vaxers and poor healthcare logistics in much of the developing world.
- Trump’s shadow remains divisive
President Biden has promised both unity and change. This will prove difficult, so long as Trump remains popular with Republican voters, thereby forcing Republican Congressmen (and women) to dance to Trump’s tune in order to keep their jobs. Biden may use the Democrat’s casting vote in the Senate, or rely on executive orders to get some of his proposed $1.9tr stimulus package through, and this might appease the Democrat left. But it will do nothing to create unity with moderate Republicans, who are in a straightjacket. For the same reason, the result of Trump’s second impeachment seems clear before any trial starts – he will surely be exonerated.
In the shadows of the politics, however, are some interesting economic arguments over how such a large stimulus should be spent that Maynard Keynes would have loved to dive into. Where is the most ‘bang for your buck’ (the so-called ‘money multiplier’) to be found? And how do you avoid a one-off spike in demand, and instead stimulate long term demand growth? What will the impact be on inflation, and who would inflation and ay accompanying rise in bond yields? The different ways of stimulating the economy all come with risks as well as benefits, whether a rise in the minimum wage, one-off handouts to families through tax credits on earnings, extension of furloughed wages, cheap loans to struggling companies, or the partial write-off of student debts.
- Valuations support equities
Real yields on risk free assets remain negative in all the major economies (ie, inflation is higher than the interest rate available on cash, or on government bonds). This makes any rotation from risk assets to defensive expensive for the investor. Investors are instead likely to remain in risk assets, whether stocks or credit, but switch into relatively undervalued parts of the markets in both asset classes.
This means equity and debt issued by economically sensitive sectors may be favoured, since these sectors are likely to see the largest rebound in earnings when normal economic activity resumes. A list of such sectors might include energy, financials, materials, and discretionary consumption (from travel to luxury goods). By region, European and Japanese stocks appear better positioned for a recovery a global economic activity than the U.S, which is now dominated by tech that had a relatively ‘good’ pandemic. Emerging market equity and bond markets both offer value relative to developed markets.
- The equity risk premium
Professional investors will often describe the valuation of equities relative to risk free assets using the term ‘equity risk premium’. This calculation illustrates why investors continue to buy U.S equities despite historic high price earnings ratios on Wall Street.
The equity risk premium is what you get paid for holding equities compared to holding a risk free asset, it is what you get paid for holding risk. It is calculated by first finding the forward earnings yield of a stock market (which is next year’s forecasted average earnings per share, divided by the average current share price). We then subtract the 10year yield of the most relevant bond market from the earnings yield.
The current forward earnings yield on the S&P500 is around 4.4%, and the 10yr Treasury yield is approximately 1.2%. This makes the equity risk premium 3.2%. Which is much less than the 6.9% at the market trough last March, but is well above the -2% at the height of the dot.com boom, and the average of 2.7% between 1996 and 2020*.
- Reddit/ GameStop – a new price-insensitive investor
The recent crowd-buying, and then selling, of GameStop appears at first glance to be a classic ‘pump and dump’, forbidden in all major financial markets. This is until one considers some important differences. There was no collusion, as normally defined, since the social media messages are for all to see. And for many participants the motivation appeared to be not so much greed, but to hurt short-selling hedge funds. For these reasons the U.S regulator, the SEC, has stood back. Besides, it is politically difficult to pursue retail investors who see themselves in a David versus Goliath fight against hedge funds.
Of course, the David versus Goliath analogy misses the point of short selling, and hedge funds that do so have a role in the eco system of financial markets. They help in the price discovery of an asset, with many instances of corporate fraud first revealed by short sellers (such as last year’s Wirecard and Luckin Coffee).
It may be that investors have to get used to a new type of price-insensitive investor, which is the social-media inspired day trader, acting in unison in sufficient numbers to materially move stock prices, with little care for an asset’s fundamental value. In this respect they join other price-insensitive investors and distorters of market prices, such central banks!
- Brexit and sterling – the Irish border question just won’t go away
Sterling is relatively stable at present, but there is scope for a Brexit discount to re-appear. Brexit is far from settled, as shown by the ongoing discussions on the level of access that the U.K’s financial sector will have to E.U markets. But few would have forecasted the re-emergence of the Irish border question as a live political issue, quite so soon after agreement was reached in December.
Two illustrations of the problem: first, the E.U (briefly) tried to have the border between the Republic of Ireland and Northern Ireland closed for the transport of vaccines out of the E.U a few weeks ago. This would have made it a ‘hard’ border, requiring customs checks, which according to the Northern Ireland Protocol agreed in December, should happen only in an emergency. Dublin and London were united in their anger, which was quite an achievement for the E.U. Then came reports of intimidation towards customs staff handling freight coming from Britain, who now have to now check all shipments of goods. For example, and of huge symbolism to the provinces’ Unionists, plants are not allowed into the province if they carry, or are in, British soil.
Although the U.K government claim these are teething problems, it appears (to the casual observer) that the problems lie in the gap between what the Northern Ireland Protocol says, and how it has been explained and understood by British and E.U politicians. It will surely need to be re-opened, and a more explicit border arrangement agreed on, if such ‘teething’ problems are going to end. This issue has the potential to be toxic if it is not addressed, but addressing it in an unambiguous manner has eluded Brexit negotiators up until now, and a solution that satisfies all sides is difficult to imagine.
Remain diversified
As always, investors should be as diversified as possible in order to maximise returns relative to risk (ie, volatility). This means geographical, sector and asset class diversification.
Stay well!
*Equity risk premia: my calculations for current estimate, Goldman Sachs Asset Management for historic estimates.
“William is a great adviser. He knows me well and my personal goals. He prepares himself well for our quarterly meetings and always monitors the maturations of my investments. Looking ahead and planning new investments.”
“Consolidated my Pensions with deVere some 8 years ago, whilst working in the Middle East. Having now retired and living in China, deVere have continued to manage my Scheme with consistent professionalism, with regular reviews and product information.”
“William has been great. He’s diligent and patient in helping us with everything from giving us regular reviews of our account to advising and assisting us with requests. He is knowledgeable about what is happening and able to answer all of our questions clearly.”
“William has been my client manager for the last 5 years. He has been very good in understanding my risk profile and guide me and my portfolio in the right direction during quite turbulent years. I’m happy to recommend William to anyone or any company that require his services.”
“deVere has been handling mine and my wife’s long and short term investments for the past 3 years. Our advisor, Will, is excellent at putting our finances into perspective and ensuring that we make the best possible decisions regarding our future.”
“deVere China (Shanghai) and my advisor William Trayford have been excellent in keeping me updated about my investment plan. They are proactive about setting regular review meetings and keep every meeting focused on the goals that I have set.”
“I have been a deVere client for many years, and built a good relationship with William during my time in China. He helped me to solve some difficulties I had, while also finding banking solutions and new investment options that fit my objectives.”
“I have been a deVere client for about 12 years during expat assignments abroad. I have been working with Will for the past 4 years whilst posted in China, and would recommend him highly. He is very straightforward, listens to my needs, and recommends products that work. Best deVere adviser I have had to date!”
