- Look for opportunities outside dominant macro drivers
- We are looking to India, South Africa and agriculture to diversify our funds
David Jane, manager of Miton’s multi-asset fund range, comments:
“A major plank of our strategy is to have a range of diversified macro and thematic ideas in our portfolios. At present, there is a very powerful rotation under way in the market’s mindset, away from the disinflationary and QE dominated era to an expansionary economic environment. We have benefited greatly from this move, having had a very low exposure to bond proxies and a short duration in our bond portfolios, while at the same time being exposed to sectors that benefit from rising inflation such as resources and basic materials.
“When a single macro dynamic becomes dominant, we like to look for opportunities which might be independent of the dominant macro driver in order to diversify the funds. Within the themes we look for good supportive fundamental data but with a narrative which is less positive in the short term, combined with emerging price momentum. To be additive to the portfolio, the themes need to be distinct from the core macro ideas but not conflicting, meaning they must not do badly if we are right on our major views. For this reason, while many of our themes have been around for a long period, the way we implement them can change to reflect a dynamic macro background.
“We have looked at some of the areas of our portfolios that might be broadly independent of the very dominant global growth and reflation theme that dominates markets at the moment, but at the same time can deliver returns.
“One such theme is the Indian domestic economy, where Modi’s economic reforms and a young workforce suggest strong growth for years to come. The Indian economy is less integrated into the global trade system than most other emerging markets and so doesn’t need a strong US/Chinese economy to do well. While performance has been very strong, and therefore we have naturally reduced our positions, we remain a long-term bull of the potential for India.
“A recently added theme is the South African domestic market. Long regarded as too risky in the Zuma era, as it became clear that Zuma would be replaced by a much more respectable and market friendly Ramaphosa, we added a small position in government bonds and equity. Within equity, we bought the domestic stocks and banks which would benefit from a better domestic economy, rather than international mining stocks. Early signs are that Ramaphosa is getting to grips with the crony capitalism which has come to dominate South Africa and the market is reacting positively through the currency, equity market and the bond yields.
“Another recently added theme is agricultural which we have followed for some time. Global demand for food continues to rise as incomes and populations grow, and with limited natural resources, productivity enhancements are needed. Agricultural prices have been falling for some time, despite other resource prices having risen, but now appear to be rising again. As they rise, demand for machinery and supplies typically also rises. We have added a range of fertiliser and machinery companies as well as more direct plays through aquaculture and farmland, in a range of regions. This theme should benefit from a broadly rising inflation environment but add further diversity to the funds.
“In coming weeks, we expect to develop further on one or more of the newly added themes, and also continue to seek out more diversifying themes in order to reduce dependence on the very dominant and powerful macro trend.”
Can equities tolerate higher bond yields?
By Frédérique Carrier, Head of Investment Strategy, RBC Wealth Management
The spike in yields of late has sent shivers through stock markets, which recently reached all-time highs and whose valuations are seen as stretched. But this rise in yields, if contained, isn’t necessarily bad news for stocks. Rather, it suggests to us that the rotation into reflation-driven cyclical stocks may have legs.
The inflation influence
Global bond yields have been trending higher for some time, but the pace of their gains has accelerated recently with the U.S. 10-year Treasury powering through 1.5 percent, its highest level in a year, up from 0.5 percent last August. Meanwhile, the German 10-year Bund yield has moved from a March 2020 low of negative 0.85 percent up to negative 0.31 percent, while the UK 10-year Gilt, which touched a low of a mere 0.08 percent last July, has jumped to 0.76 percent of late.
In last week’s issue, we laid out how yields are being driven higher by rising inflation expectations as the global economy heads towards further reopening. WTI crude oil is a case in point: currently at more than $63 per barrel, it compares to an average price last year of $39.
The reopening of economies seems increasingly imminent to us. Recent vaccine data from Israel, where the rollout is most advanced, suggests vaccination lowers the transmission rate of COVID-19, fueling additional optimism for a faster, wider easing of restrictions.
Inflation expectations are also on the rise in the U.S. due to concerns there may be more fiscal stimulus in the pipeline than the economy needs. RBC Global Asset Management, Inc. Chief Economist Eric Lascelles thinks another relief package perhaps on the order of $1.5 trillion will ultimately pass, coming on top of the $900 billion stimulus delivered last December. Together, these two would amount to some 10 percent of GDP in additional stimulus among signs of the resilience of the U.S. economy in the face of the COVID-19 shock. Case in point, the ISM Manufacturing Purchasing Managers’ Index was at 58.7 in January, far above the average since 2000 of 52.7. More stimulus in the form of an infrastructure bill may also be possible this year, but would likely take time to filter through to the economy.
However, Fed Chair Jerome Powell suggested in his recent testimony to Congress that inflation fears may be overdone.
He pointed out that the pace of improvement in the labour market has slowed, as has that for the overall economy, while prices remain rather soft in the sectors most affected by the pandemic. In other words, the U.S. economy will likely remain below potential for some time even as it reopens.
Powell’s testimony, the Fed’s commitment to allowing inflation to overshoot its target, and the high level of government indebtedness persuade us that the rise in yields will be contained. As we pointed out last week, sharp rises in Treasury yields are typically followed by range-bound trends. We expect the U.S. 10-year Treasury yield to settle between 1.5 percent and two percent on a one-to-two-year horizon.
Higher yields not necessarily a problem for equities
Investors have been concerned that higher bond yields may threaten equity valuations, which are now in excess of long-term averages. After all, a share price reflects the present value of future cash flows, and if the discount rate increases, the value of future cash flows decreases.
In practice, however, that is not always the case. In fact, since the March 2020 lows, equities have gained on the days when bond yields were up and retreated when bond yields fell. That is because the market interpreted higher bond yields as a sign of improving economic growth prospects. In fact, similar behaviour has played out since 2000 (see table).
As long as yields hover around two percent and are up due to expectations of higher growth and inflation, we would expect this relationship to hold. After all, equity markets were strong prior to the pandemic when yields were at two percent—though admittedly, valuation levels were not as stretched as they are now with the S&P 500 trading at 22.1x the consensus forward earnings estimate versus a 10-year average of 16.1x. But it would be unusual for price-to-earnings ratios to contract meaningfully in the midst of an earnings growth cycle when central banks are still supportive. Moreover, according to RBC Capital Markets, LLC Head of U.S. Equity Strategy Lori Calvasina, just over half of the companies in the S&P 500 today have a dividend yield in excess of the 10-year Treasury yield, suggesting the search for yield should continue to underpin stocks.
More concerning would be a sharper rise in yields, one much beyond that two percent level. Calvasina finds that stocks often struggle when yields climb more than some 275 basis points. For such a move to be replicated today, the 10-year yield would need to reach 3.25 percent.
Likewise, an increase in yields brought on by concerns about Fed tapering, i.e., a reduction in the Fed’s bond-buying programme, could also upset the apple cart as it would highlight the risk of the economy being close to overheating. But tapering is not likely before next year, in our opinion.
Overall, we think developed equity markets can cohabitate with higher bond yields. In Calvasina’s view, volatility may increase and there could be more pressure on the shares of highly valued companies, particularly if such companies disappoint in some way (e.g., an earnings miss).
We believe the increase in yields will underpin the rotation into reflation-driven stocks, which started last November. In turn, defensive and secular growth stocks, which drove performance in 2020, may lag. As such, Tech stocks may become vulnerable to profit-taking (this would be in line with the sector leadership rotation observed around bond yield increases in previous cycles). In addition, the performance of the Health Care sector and certain areas of the Consumer Staples sector such as food producers may well be underwhelming going forward.
According to Calvasina, the Financials and Materials sectors show the greatest tendency to outperform when yields are rising, with their performance closely linked to shifts in inflation expectations. She notes that both sectors in the S&P 500 continue to look deeply undervalued.
With the rise in bond yields this year likely to be contained, we maintain our Overweight stance in global equities, as we expect to see modest gains over the course of 2021. In the current environment, the recent sector leadership rotation towards reflation-driven stocks looks set to continue.
As sustainable investing becomes mainstream, where are the opportunities?
New whitepaper from CAMRADATA
Although Covid-19 brought the world to a standstill, and the initial shock led to fears around the progress of sustainable investing, sustainable funds hit a record high of $1.25 trillion (as of the end of Sept 2020), with Europe passing the $1 trillion milestone, according to Morningstar data[i].
CAMRADATA’s latest whitepaper on ‘Sustainable Investing’ seeks to discover sustainable investing opportunities for investors as the biggest transfer of generational wealth in history (c.$60 trillion) takes place over the next couple of years, with millennials in particular watching this space and deploying capital accordingly.
The whitepaper includes insights from Aegon Asset Management, Kempen Capital Management, The Investor Forum, Isio, Redington, RPMI Railpen and Tobacco Free Portfolios who all attended a virtual roundtable hosted by CAMRADATA in January.
The report highlights that financial models have traditionally failed to adequately capture ESG risks and in turn, ESG issues will continue to drive future market trends.
Sean Thompson, Managing Director, CAMRADATA said, “ESG is here to stay – as evidenced by last year’s inflows. In the first five months of the pandemic alone, there were more inflows into ESG funds than over the previous five years.
“But beyond the inflows of 2020, what will be closely watched this year is sustainable investing at the federal level. After the enforcement of environment protection hit a 30-year low with the Trump administration, President Joe Biden has started the process of re-joining the Paris Agreement.
“This could cause a tipping point along with commitments by China, the EU, Japan and South Korea. But while the move is welcomed at a grassroots, municipal, state and international level, young people will be watching, and calling out any violations. Our panel explored the issues and considerations for sustainable investors this year.”
One key discussion point was if there was enough data available for sustainable investors, with some saying that despite increasing volume, there was inadequate data. Others were worried about information overload and too much data.
The panel also discussed the need for asset owners and asset managers to focus more on health, in particular in relation to tobacco holdings.
Here is a round up of key sustainability issues for investors, and what it means to be a sustainable investor in 2021.
Key takeaway points were:
- Companies and asset managers need to collectively get better on the voluntary disclosure and guidance frameworks that underpin ESG reporting.
- Metrics help shareholders and analysts to understand how far a company adheres to its purpose but it is often the largest companies that have the most resources to supply data on sustainability.
- Lateral engagements mean that best practice can be disseminated throughout a sector, with greater results. If the leaders in a sector set an example, the rest will follow.
- One long-term investor said they look decades into the future. Society is against tobacco; is more and more against fossil fuels, and is now recognising the negative effects of alcohol, demonstrating that over the long term sustainability considerations will impact the financials.
- Ethical factors and ESG factors are distinct concepts that might or might not coincide. One panellist said ethical is often linked to reputation, whilst ESG is about the extent to which financial outcomes can be shaped by governance and sustainability.
- Good managers articulate clear firm wide ESG goals and then apply them consistently across their entire fund range
- Another panellist said that if a portfolio manager can’t explain how their fund’s ESG integration fits into their firm wide objectives and stewardship priorities, then the fund will not receive a good ESG rating.
- Issues that investors will focus on this year include social justice and diversity, stewardship and the new Stewardship Code, and decarbonisation of portfolios.
- One panellist said they would be running training workshops for client-facing consultants on all matters ESG, and another that they would be encouraging asset owners, beneficiaries and assets managers to understand the UN Tobacco Control Treaty, signed and ratified by 180 countries.
- A final comment was on the merits of engagement, with one panellist hoping that enhanced stewardship disclosures in 2021 would provide much more transparency on both the scale of, and impact from, engagement.
UK earmarks a further $2.3 billion for its COVID vaccine push
LONDON (Reuters) – British finance minister Rishi Sunak will announce an extra 1.65 billion pounds ($2.30 billion) to fund the country’s fast vaccination rollout as part of his annual budget statement on Wednesday, the finance ministry said.
“Protecting ourselves against the virus means we will be able to lift restrictions, reopen our economy and focus our attention on creating jobs and stimulating growth,” Sunak said in a statement.
Britain has so far given a first vaccination more than 20 million people, or more than one in three adults, Europe’s fastest vaccination rollout.
“The new money will continue to vaccinate the population and ensure every adult is offered a dose of a vaccine by July 31,” the ministry said.
A further 33 million pounds will be spent on vaccine testing and development to protect against future outbreaks and variants and 22 million pounds will fund a study to test the effectiveness of combinations of different COVID-19 vaccines.
(Writing by William Schomberg; editing by Philippa Fletcher)
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