Investment Environment February 2021

15.03.21

COVID-19 vaccination progress

The number of vaccines administered worldwide have increased substantially from 86 mil at the end of January to 241 mil at the end of February.  The increase is being driven by the largest countries / regions as they have access to vaccines as well as infrastructure to distribute and administer.  The further roll out is likely to continue to gather pace as the manufacturers distribute their vaccines to countries who are contracted to them.

Israel continues to lead the vaccination rate with 88.5% at the end of February.  Israel have predominantly used the Pfizer vaccine and provided very good efficacy data to conclude the effectiveness of the vaccine in stopping the spread of the virus. Israel will also in all likelihood be the first country to demonstrate “herd immunity” which is vital to contain the virus.

241 mil doses have been administered worldwide. This compares favourably with 86 mil doses admistered at the end of January.  Whilst this seems like a lot in a short space of time there is a long way to go as shown in the penetration rates per country.

Fiscal stimulus, interest rates and risk free rate

The graph shows the US Treasury Yield Curve, which is essentially the risk free rate of the global economy.  Financial assets are generally valued using a discounted cash flow model whereby the future cash flows are discounted at a rate which comprises the risk free rate plus a risk premium.  If the risk free rate decreases the valuation of financial assets typically increases – all other things being equal.  The converse applies if the risk free rate starts to increase. 

The X axis shows the various maturity dates and the Y axis the yield.  Generally an investor wants to be rewarded for a longer maturity as the risk increases.  What you can see is how the short (1 month to 3 years) and medium (3 years to 10 years) term yields have dropped since 31 Dec 2019. The cause of this has been slowing growth in the US economy causing the US Fed to try and  stimulate the economy with monetary policy (i.e. cutting interest rates).  

We have used bonds successfully in the portfolio to benefit from a decreasing interest rate environment.  The future shape of the yield curve provides an indication of economic activity in the future.  An upward sloping curve provides guidance that an economy is improving and growth is returning.  Of particular importance is the 10 Yr yield.  We have seen a sharp increase in the yield from 0.55% in July 2020 to 1.44% on 26 Feb 2021.  This signals a sharp recovery in the US economy but also potentially indicates a rise in inflation and interest rates. 

The valuation of financial assets (equities and bonds) have reacted negatively to this and sold off in the last week of February.  The market is therefore pricing in a rise in interest rates from 3 years out which is sooner than what the US Fed has indicated.  If the market is correct in its assessment then financial assets will continue to come under pressure in the short term.  We are of the view that interest rates will continue to remain lower for longer and consumer inflation pressure will not react unduly to the the significant stimulus provided by the US Fed.  We do view the size and extent of the stimulus packages as fuelling asset inflation but not consumer inflation.  

Biden has managed to get his $1.9 trillion stimulus package passed by the House.  It now needs to get passed by the Senate before it is implemented.  We are of the view that there is a high probability that the package will succeed and be implemented in the not too distant future.  This should weigh on the US dollar but provide income for unemployed workers and businesses badly affected by the COVID pandemic which might stimulate the US consumer to some extent.

All equity indices had a positive month in February with returns up between 1.2% - 3.6%.  The MSCI FTSE index was up 3.6% whereas the MSCI Emerging Markets index was up 1.2%.  The S&P500 continues to be the best performing index with an annualized return of 23.5% (over five years) and 14% (over 3 years).  Global Tech and Healthcare continue to be the drivers of out-performance over this reporting period.

Earnings & Valuations

S&P500

Qtr4 2020 earnings season is virtually complete with 96% of companies having reported.

Overall Qtr4 2020 earnings have been positive for the S&P500 (3.9%).  Materials (22.3%), Financials (17.6%), Information Technology (17.2%), Healthcare (13.77%) and Communication Services (10.7%) have been the standouts.  We continue to favour the IT and Healthcare sectors given their superior growth and have more recently added some exposure to Materials through a specific ETF given the cyclical upturn in commodities.

Full year 2020: Earnings for the S&P500 however have been negative (-11.2%) as shown in the graph below.  The two stand out sectors have been Healthcare (10.8%) and Information Technology (7.9%).  The laggards have been the sectors heavily affected by the COVID pandemic namely Energy (-108.9%), Industrials (-54.2%), Consumer Discretionary (-26.9%) and Financials (-20.2%).

Qtr1 2021: earnings forecasts are shown in the graph.  Consumer Discretionary (85.8%), Financials (66.3%) and Materials (43.1%) show a significant rebound as the world economy bounces off the lows of Qtr1 2020 when the pandemic was at its worst in terms of disruption.  The S&P500 is looking to grow by 21.5%, which is encouraging and will go a long way to narrow the gap between price and earnings growth.

The S&P500 continues to look fully priced with the growth in price outpacing the growth in earnings.  The supportive fiscal and monetary environment will prevail for the time and therefore a major correction in unlikley in the short term.  The key trigger for a correction of some sorts could be  when inflation appears  to return followed by an increase in interest rates. The upward movement in the US Treasury Yield curve as mentioned earlier provides a view by the market on their expectations for future growth, inflation and interest rates.  We are watching this carefully and will look to take the appropriate action in your portfolio.

Portfolio positioning

Generally we continue to maintain equity exposure in the 40% - 60% range with the majority invested in the S&P500, Information technology and Healthcare sectors.  In some cases we have added some cyclical exposure to the Materials sector given the outlook for commodities.  Also, depending on the client’s mandate, in some cases there is exposure to Emerging Markets, Europe and UK to make up the overall equity allocation.  All three of these geographies have benefitted more recently from a weakening USD and a re-rating.

Exposure to bonds has worked well for the time being given the downward move in the US Treasury Yield Curve with maturities less than 7 years.

Listed property has suffered the most from an asset class perspective given the uncertainty created by COVID.  The listed US real estate ETF has continued to provide a steady flow of income (approx. 3.5%) meaning that the underlying businesses that make up this ETF have proven to be resilient in these tough times.  This asset class has re-rated over the past 3 months as the success of the vaccine roll out starts to take shape.

Physical gold and platinum have been added to the portfolio in some cases.  The reason for investment in  Platinum is two-fold: 1) platinum is currently trading in a supply deficit which is supportive of the price as demand, particularly out of China (autos and jewelry) continues to prevail; the breakeven all in cash cost for platinum is approx. $860 an ounce which provides some downside  protection in our view 2) it provide hedge against a weakening USD as the opportunity cost to hold physical metal is zero with no interest rates.  Gold was added to provide diversification benefits to the portfolio.  The price of Gold has decreased since being added to the portfolio driven by a “risk on” environment but we believe Gold has been oversold in the short term.  In addition, investors have switched their physical gold exposure to Bitcoin as a store of value.  We remain skeptical of gold being replaced by “liquid gold” or cyber currency as a store of value.  Should there be a major correction in the price of Bitcoin, Gold will likely be the beneficiary thereof.  In many of the portfolios we have achieved an exposure to both platinum and gold by a holding Sibanye Stillwater.  Sibanye Stillwater is a well run business and a beneficiary of higher PGM and Gold commodity prices and the share price remains at reasonable value.

Another area of interest is the clean energy sector and we have added or are looking to add a Clean Energy ETF and a Lithium ETF.  The cost of renewable energy has decreased significantly over the years making it very competitive with traditional sources of energy.  We also believe that Biden will promote climate change, has advocated rejoining the Paris accord and implement policies to fast track the adoption of renewable energy which should benefit the companies included in this ETF.  Lithium is a key commodity used in the manufacture of batteries.  The price of lithium is largely determined by China.  We have seen an uptick in both the price of lithium as well as the demand to support the growth in electric vehicle adoption.  This ETF should benefit across the whole value chain from mining, refining and manufacture.

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