The (in)famous ex Chair of the US Federal Reserve was well known for talking a lot without saying much, a key skill when his public pronouncements often moved markets. He himself came up with the famous quote “if you understand what I’m saying then you aren’t listening carefully enough”. This is a phrase that could be used for today’s markets. If you think you know what is going to happen next, then you don’t really understand what is going on. This is no more an observation than saying the scale of stimulus and economic strength at the same time is unprecedented. For example, to have emergency stimulus measure being poured into the US economy at a time when it is clearly booming has not been seen before. No wonder the market worries about inflation. But like all things that are unprecedented, a degree of humility is needed when considering what may happen next. The last 18 months has seen a series of events which have defied expectations: the shutdown of the global economy followed by a bounce back in speed and strength that no one forecast. Should we be surprised if what happens next is a surprise?
History doesn’t repeat but it does rhyme
Another famous story is when the Allied army asked for a weather forecast many days ahead for the D-Day landings. When asked, the Chief Meteorologist protested that giving an accurate forecast so many days ahead was impossible. To which the response was “give us a forecast anyway, we need it for planning”. The landings themselves were postponed due to unforeseen bad weather. It feels a bit like this with investment strategy now; we know our views are likely to be wrong, but we have them anyway to plan around. Our most useful observation is that the pandemic, in market terms, is following closely the financial crisis. 2009 and 2020 were very similar, a market panic followed by huge stimulus followed by a V-shaped recovery. 2021 is shaping up a lot like 2010, a strong economic recovery with inflation concerns coming to the fore because of stimulus measures undertaken at the peak of the crisis. This led to a value/cyclical market such as the one we see today. What happened next in 2011? Inflation concerns subsided and debt, demographic and technology kicked in as deflationary forces and the investment environment returned to corporate outcomes determining investment outcomes. Could this be 2022? That isn’t clear, but it is a possibility and as markets look ahead it becomes more relevant as a scenario to plan around.
Growth stocks derate fast!
One of the great features about owning growth stocks is they get cheaper quickly. Just think about earnings growth. A stock growing earnings at 10% will, if the share price is unmoved, be 10% cheaper in a years’ time on headline multiples. Add into this some market rotation, with many growth stocks being 10-15% from their highs, and suddenly we have growth stocks looking 20-25% cheaper than the recent past. This is what is happening currently. The growth stocks we own are continuing to deliver strong profit growth, yet their share prices are down as investors look to invest in more cyclical/value areas of the market. As we look forward to 2022, which investors tend to do as we pass the half year, we think many growth stocks are now looking to be on the favourable side of fair value. Equally those companies that cannot deliver growth rerated quickly. Once we exit this period of economic acceleration and recovery, those companies operating in disrupted and low growth industries will struggle to support rising share prices rising further. It still feels too soon to call the end of the value/growth rotation as bond yields could move higher, but there is some light at the end of the valuation tunnel.
Performance has improved, but still too soon to call the turn
2020 was a good year for our funds, with something of a sting in the tail between vaccine day, November 9th, and the end of the year. But our funds ended the year nicely in Q1 and ahead of benchmarks. The start of this year has been tough not because of stock specific issues, which have been no more or less than in an average year, but for the pronounced rotation into value and cyclical names which hasn’t suited our sustainable, growth orientated, large cap investment approach. Generally, the companies we are invested in continue to perform operationally very well and this has become more apparent in April and May when markets, whilst still volatile, have been more balanced. This has allowed the strong operational performance to determine the outcome of our portfolios, rather than bond yields
One new idea in, one favourite leaving
Despite markets being at historically high levels we are still finding opportunities. Two key areas we are interested in are decarbonisation and digitisation, both of which will make the world environmentally better. Decarbonisation has a subset, which is electrification. The more we can move to renewables to generate our electricity, the more sense it makes to electrify a whole range of industries. We see this with electric vehicles, and it will broaden further. Electricity has been a sub GDP industry for many years as energy efficiency has offset underlying demand growth. We think this is about to change though and will benefit several companies we own. Equally we think digitisation in the industrial world can make manufacturing processes and factories more efficient and environmentally friendly. For these reasons we have started a holding the French company, Schneider Electric. Schneider Electric is the global leader in Energy Management and Industrial Automation and is great way to play the dual trends of electrification and digitisation.
One of our longest standing investments, St Modwen, received a bid recently and we have used the opportunity to exit this position. St Modwen is an urban regenerator working on brownfield sites to develop housing and warehousing for broader use in the economy. We have had a holding in St Modwen for over 20 years and are sorry to see it leave our funds. That said, the price is favourable and as the least liquid investment we had within our equity funds this was an ideal time to sell our position.
Our upcoming Advisory Committee Meeting
At the end of June our external Advisory Committee (Adcom) will meet to discuss a range of topics of interest to us and our clients. We are asking the Adcom to consider if there are any circumstances under which a mining company could be owned by our funds. Like oil & gas, we have avoided this sector due to the environmental impact of mining, and generally more problematic ESG standards. There is however a critical difference between mining and oil. Oil can be replaced by renewables, whereas wind turbines cannot be built from wind! There is a saying that we will need to mine ourselves to Net Zero, especially as we need lots of copper to deliver electrification. We will also be discussing human rights and the situation in China and Xinjiang, where the Uyghur population have been subject to several abuses. Adidas, which we own, has quite rightly stated it will not source cotton from Xinjiang, but has come under attack from the Chinese government which instructed its products be delisted on from key e-commerce websites. We are supportive of Adidas even if it has impacted its share price. We will be asking our Adcom how we should be talking to companies about their role in situations such as this and what are the realistic expectations we should set for those companies we invest in. As always, this should be an interesting meeting.
Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.