Up and away
The US S&P 500 Index hit its Covid low in March last year at 2237. Since then, it has more than doubled to stand at its current level of around 4500. For anyone who believes in efficient markets this is a mortal blow. To have one of the most liquid and closely followed markets in the world double in less than 18 months demonstrates that significant opportunities will periodically be presented to investors. Last March we noted this was the third big buying opportunity of our careers (September 2001 and the financial crisis being the other two – note the role of fear and panic). However, we have been surprised at how rapid this ascent has been.
The key piece of information that was not understood last March was that that overall corporate profitability would be higher because of the pandemic than if the pandemic hadn’t occurred. This requires a double take. Yes, you did read that right, the profitability of corporates in aggregate is higher now than it would have been had the pandemic not occurred. To understand this, look at the composition of the global economy. One of the biggest sectors is information technology, which is currently 28% of the S&P 500, while another big sector is healthcare, currently 13.4% of the S&P 500. These are both sectors whose prospects have been materially improved by the pandemic, creating a tailwind to overall levels of corporate earnings and equity indices like the S&P 500 which follow them. This has more than offset the problems of industries such as retail and travel.
"The profitability of corporates in aggregate is higher now than it would have been had the pandemic not occurred."
New market highs also reflect some profound changes in the way all businesses operate. Despite all the talk of inflation, supply chain disruptions and labour shortages, corporate margins are at record-highs. Why? These very headwinds are creating a productivity boom via the adoption of technology, which is not only fuelling the IT sector itself, but all corporates. We think there are very few examples of companies who are truly technology driven and have fully embedded the benefits of automation, cloud computing and AI into their businesses. The pandemic, and the associated problems it has brought, is the catalyst for this changing. We are witnessing a substantial re-engineering of the corporate sector right in front of our eyes. There is a technology boom, and one which should make the corporate world more profitable and valuable over time.
Winston Churchill once said "I cannot forecast to you the action of Russia. It is a riddle, wrapped in a mystery inside an enigma; but perhaps there is a key. That key is the Russian natural interest". I believe it is possible to replace ‘Russia’ with ‘China’ in this statement, especially in the context of recent events. China has begun a clampdown on private enterprise in the name of social equality and common prosperity. What started as an intervention in the for-profit education sector has evolved into areas such as real estate and technology, with new regulations and laws being enacted to materially change the purpose and business models of companies in those sectors. Investors in the Chinese education sector have seen their investments wiped out, and the share price of Chinese internet giant Alibaba has halved.
China is a hard economy and society to understand for those not born into it. As a one-party communist state, it values social stability above all else and can be brutal in how it acts to deliver this, something we have witnessed recently in Xinjiang with the Uyghur population. In this context it is unlikely Xi Jinping, the President of the People’s Republic of China, is going to lose much sleep over shareholder losses.
China has of course had a mixed view of capitalism for many decades. Prior to Jiang Zemin, who became president in 1989 soon after the Tiananmen Square protests, China had been a closed economy. Under his leadership however, which ended in 2002, there was a significant opening up of China, culminating in it joining the World Trade Organisation in 2001. This led to 20 years of strong economic growth as foreign capital flowed into the country and exports flowed out. What we have seen of late is perhaps the first sign of this trend reversing, with the redistribution of wealth and greater control of private enterprise becoming a social priority. Although there are philosophical arguments to say why these are worthy goals, history has taught us they are universally bad for economic growth.
"China has been the most important driver of global growth for many years"
This is relevant as China has been the most important driver of global growth for many years now, and there is certainly no expectation for any material slowdown in the coming years. This is our central case too, but if Xi Jinping really is rolling back private enterprise and disincentivising innovation by redistributing wealth away from entrepreneurs who created it, that is something which markets will have to readjust to. For those worried that there is nothing left to worry about in markets today, this is a tail risk well worth keeping an eye on.
August was a strong month for our funds and we believe that this is turning out to be a good year for the RLAM sustainable funds (for latest factsheets, please see the RLAM fund centre). Given the rally in commodities, and somewhat better performance of value stocks recently, it is perhaps a little counterintuitive. It must be said our equity exposure, which is growth orientated, has benefited from the recent fall in bond yields but that isn’t the whole story.
"I believe that the fundamental premise of sustainable investing is alive and well."
Arguably more important has been the consistently strong operational performance of the companies we invest in. Whilst the investment community thinks in terms of value and growth, the corporate world thinks in terms of end markets and business opportunities and the winners and losers in that context are ever clearer. Sustainable funds, and RLAM’s within that, are a simple way of investing in a post pandemic world where the investment winners and losers will become even more polarised. Of course, anything can happen in the short term, and there are likely to be more twists and turns before the end of this year, but I believe that the fundamental premise of sustainable investing is alive and well.
As we often remind ourselves, the future is one of probabilities, not certainties. We are in the middle of an unprecedented set of circumstances, where strong economic growth is still being met with very accommodative monetary and fiscal policies. The outcome of this could be bad (runaway inflation) or good (strong corporate profitability) or maybe a mixture of the two. There are certainly plenty of commentators out there with strong investment track records who think this will end badly. To that we can only add our own views, but these are only probabilities:
- We are probably in the latter stages of the equity bull market which began in 2009. Markets are currently doing a good job of clipping the wings of ambiguous business models (the Zoom share price has nearly halved from its peak) and the increasing speculation from retail investors in meme stocks is probably an irritation rather than something systematic. Overall, while markets are not cheap (nor should they be) the weight of evidence does not support a bearish view currently and it should be noted the latter stages of bull markets, which are measured in years not months, are often the most profitable.
- The global economy will probably stay strong through 2022 and maybe into 2023. Absent any issue (such as China discussed above or a new Covid variant) household balance sheets (savings plus the value of assets) have never been stronger, and unemployment is ratcheting lower. Corporates generally have strong balance sheets and are keen to invest. There is still plenty of pent-up demand as we revert back to pre-pandemic activities. This should offset any retrenchment from governments via higher taxation and other levers to reduce debt post Covid.
- Growth will probably continue to outperform value. In a mean reverted post pandemic world, the business opportunities will be much larger for growth industries than those tagged as value. Although it could be argued that valuations have moved to reflect this, we are not so sure. It is hard to make money from businesses going backwards, and in a post pandemic world, which will create many new structural losers, there are certainly more of these than ever before.
So overall, my view is that equity markets are more likely to continue to move higher rather than pull back, that the global economy will be strong, and the winners of recent years will be the winners in the coming months. Of course, keep an eye on inflation and China, but there is always something to be worried about!
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.
Royal London Sustainable Managed Income Trust, Royal London Sustainable Managed Growth Trust, Royal London Sustainable Diversified Trust, Royal London Sustainable Word Trust and Royal London Sustainable Leaders Trust are held within RLUM Limited Unit Trusts, which is an authorised unit trust scheme. The Manager is RLUM Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144032.
The RL Global Sustainable Equity Fund is a sub-fund of Royal London Equity Funds ICVC, an open-ended investment company with variable capital with segregated liability between subfunds, incorporated in England and Wales under registered number IC000807. The Authorised Corporate Director (ACD) is Royal London Unit Trust Managers Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144037.
The RL Global Sustainable Credit Fund is a sub-fund of Royal London Asset Management Bond Funds plc, an open-ended investment company with variable capital (ICVC), with segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. It is a recognised scheme under section 264 of the Financial Services and Markets Act 2000. The Investment Manager is Royal London Asset Management Limited. Most of the protections provided by the UK regulatory system, and the compensation under the Financial Services Compensation Scheme, will not be available.
For more information on the funds or trusts or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk.