It’s that time of year for reflection and looking ahead. This time, of course, everything seems more momentous than in previous years (I won’t use the word “unprecedented” for reasons which will become apparent).
Since my last message we have received good news on vaccinations but worrying spikes in infections, particularly in the South East and The North of the UK. We continue to be prudent in how we interact with our clients. The bulk of this missive contains Ben’s view on markets, but I would like to preface it by thanking all of you for your forbearance in this challenging year. Similarly, I’d also like to put on record my thanks to our wonderful staff who have continued to offer a first-class service to our clients either in the office or from their homes. We will enjoy some ‘virtual’ time together tonight at our very socially distanced Christmas ‘do’.
Investment Director Ben Yearsley’s 2020 review and Outlook for 2021
Perhaps my least favourite word of 2020 is “unprecedented”. From companies, to politicians, to fund managers, it is most overused, especially as most of the population are aware that this year has been unprecedented.
Going into 2020 I was positive on the outlook. Boris had just been elected with a thumping majority, the threat of the hard left taking power had receded, and Brexit was well on the way to being sorted. Crucially COVID-19 was unheard of. We end 2020 in the UK with debt to GDP over 100%, many employees still on furlough (another word that was unused at the start of the year), Brexit back in the headlines and the deepest and sharpest recession in history.
The standout equity markets this year have been the US and Japan. US market performance has been nothing short of stellar, despite having a patchy record dealing with the pandemic and President Trump still not conceding the election. Stating the obvious but US markets have done well due to some clear winners from enforced lockdowns and working from home; Amazon, Microsoft, Zoom, the list goes on. Many of these companies started the year on an expensive rating and are even higher now. The US markets reached new all-time highs during November whilst the UK markets are 20% off their highs and in no danger of record breaking any time soon.
The other major winner from an equity perspective has been Japan. Unlike the US, it has had a good pandemic with cases contained despite the elderly population. It has also benefitted from a flight to safety for the Yen which often happens. Probably the key reason for the performance though is the quality and strength of corporate Japan. Admittedly the data is a few months old (from Man GLG) but 56% of Japanese listed companies had net cash on the balance sheet (i.e. more cash than debt) compared to 20% in the UK and only 15% for S&P listed companies. This solidity has been vital in 2020.
Government bonds have had a great year – acting as a diversifier at a time when markets fell sharply. At the start of 2020, the 10-year gilt yielded 0.76%, and today pays 0.29%. A similar story is seen in the US where the ten-year Treasury pays 0.84% today and started the year offering 1.88%. Is this surprising when central banks have been hoovering up gilts and treasuries at record levels? Gold is another asset class that has had a strong run. $1,519 at the start of 2020 and $1,844 today, having closed above $2,000 in the summer. Safety assets have delivered.
All crises are different. The drop in GDP this year could be described as voluntary, therefore the rebound was always going to be different and swifter. The recent GDP numbers for October showed anther uptick, albeit only 0.4% growth. What seems evident though is high public sector levels of debt are here to stay for the foreseeable future and interest rates are set to remain low. Both factors will have a big impact on the investment landscape for many years.
This time last year I said there were three things to watch for in 2020: US presidential election, US interest rates, and Brexit. Well, you could argue all three have been quite important, but clearly COVID-19 has been the only event of 2020. Black swan events are rare, but when they happen, they have profound and unforeseen consequences.
My FTSE 100 prediction for 2020 was to finish the year at 7850. Clearly, I got that wrong. I will caveat that by saying I did say ignore all predictions in last year’s review! Who knows where markets would be without COVID-19, but much higher than where we are today would be my best guess.
Three things to watch for in 2021
Firstly, the speed and effectiveness of the COVID-19 vaccination programme. Clearly the quicker this happens, the quicker the return to normality and the quicker the economic hit can be reversed. Governments around the world will be releasing regular updates so watch this in conjunction with the latest infections data.
The next thing to keep your eye on is President-elect Biden’s policies, especially around tax, healthcare and infrastructure spending. Obviously, the Georgia Senate run-off election in January will be closely watched as, if the Democrats win both seats, this gives them control of the Senate and means Biden can be far more aggressive with tax rises and his overall agenda. At this point the Republicans are favourite to win the seats. A split Congress is good for markets as very little gets done.
Finally, inflation, or maybe I should say watch out for both deflationary signs and inflationary ones. Many are using the financial crisis of a decade ago as the model to say inflation won’t return as it didn’t then. However, with globalisation currently on the wane and the sheer amount of stimulus thrown at markets and economies will this time be different?
I’ve shamelessly stolen the chart below from Schroder’s Value team. It shows how the extremely sharp rotation from value to growth on “vaccine” day barely moved the needle in terms of relative performance despite being the biggest ever one day swing between these two competing styles. In other words, value as a style is still cheap on a global basis both in relative and absolute terms.
Parts of global equity markets look expensive, mainly US technology companies, but that aside global valuations look ok with some cheap areas with good growth prospects. Asia is trading above long run averages but with good growth prospects and arguably a better handling of Covid-19 the region looks well placed. The 2020s could be the decade for Asian markets especially if the US dollar weakens.
The UK market
The UK is an extremely cheap market on many valuation metrics. A combination of Brexit shenanigans, political instability and then Covid-19 has left the UK market unloved and under-owned on a global basis. With all three problems in retreat, with maybe the exception of Brexit, investors are starting to see the merits. Indeed, you can see that with the number of takeovers to occur in the second half of this year.
The other factor that has harmed the UK more so than many other markets is the dividend culture here in a year when dividends have fallen about 40%. Next year should see a decent rebound, indeed as I write this the Bank of England has just signalled that banks should be able to restart dividends in 2021. Other companies who did emergency fund raising earlier in the year are also either paying dividends again or conducting share buy backs.
Sterling is still dominated by Brexit. As I write this the chance of a trade deal seems to be receding, however even if there isn’t a comprehensive deal there will be a series of small deals that will give some confidence back in the UK. It is easy to see the pound rising from here, maybe not back to pre-2016 levels but certainly a 5-10% bounce. This of course has a huge impact on investors with overseas portfolios potentially taking an equivalent hit. At the same time this would be a boost for many UK businesses though not the FTSE 100 where 70% of revenues are derived overseas.
I said it last year and was wrong about bonds, especially government bonds, but I will basically say the same thing again. I don’t see any value in government bonds in developed markets at these levels. They acted brilliantly in 2020 as a diversifier when markets fell to pieces, but with the ten-year gilt yielding 0.29% the risk is all on the downside if either rates increase or inflation returns. The only really value in fixed interest seems in higher yielding and emerging markets where you are clearly having to take a lot more risk to eke out a return. Interest rates are nailed to the floor for the next few years, if not the next decade and there is simply too much debt sloshing around the financial system.
The chart below from Bloomberg shows the amount of negative yielding debt sloshing round the financial system. At $18 trillion it’s at the highest ever level now. Whilst this is good news for borrowers, it’s clearly a warning sign about the health of the global economy and how policy makers have distorted markets.
With the outcome of the FCA review into property funds still uncertain there is a cloud hanging over the sector. Add in the uncertainty over two key sectors (retail and offices) and the short term outlook isn’t great. What is true though is that property is needed, but maybe not the same type of property as a decade ago. Data centres and logistics centres continue to be the hot spots as they were in 2019 and this year.
Infrastructure has been stable this year, actually not a bad result with the wild swings we have seen in equity markets. With government bonds offering more downside risk than potential return it is easy see how infrastructure with stable cash flows and inflation linked income streams filling the void. Clearly some infrastructure has been massively hit in 2020 – airports being the obvious area, but we will return to air travel and many of these assets are monopolistic in nature.
As mentioned earlier gold has had a great run in 2020. With the world returning to some kind of normality it’s hard to see that stellar performance continuing into 2021 unless we have inflation and rates are kept on hold (which they will be). Don’t forget gold doesn’t really have any useful purpose.
Last year I said that the FTSE would end 2020 at 7850. Unless there is some Brexit or vaccine induced euphoria, I’ve missed that by a wide margin. For 2021 I’m going to suggest the FTSE 100 finishes at 7500. With dividends returning and GDP growth continuing to rebound it should be a reasonable year, as long as politicians don’t ruin it by doing silly things. Brexit will be fudged but the vaccine effect will start rolling through the economy and the UK market will start the year cheap, bringing a host of investors back. As ever though take any FTSE prediction with a large pinch of salt.
Jon Treharne MD