"Where to from here"
Updated: Apr 30
In our 4th quarter market commentary (www.bacci.co.za/post/bacci-quarterly-comment) we covered in detail the recent gains markets have experienced, along with some insight into our macroeconomic view, but following a strong start to the year it is clear we are facing challenges now which require some consideration.
This must not be confused with the point that something must either be bought or sold, but if after looking at all the evidence in front of us, and evaluating the current positions and asset allocation in place, we choose to remain unchanged, this in itself is a very important decision.
A lot has been discussed around the “market” valuations we are looking at and it is hard to argue with the fact that we are now at extended levels. Excluding Japan, all major markets appear to be trading at a valuation that exceeds their 25-year average. It is important to note that this in itself is not always an indicator of an imminent correction.
Source: FactSet, MSCI, Standard & Poors, JP Morgan Asset Management at 31 January 2021
The graph below gives an interesting viewpoint of expected returns for the market going forward. When markets reach the current levels it often stimulates discussions around market timing and people begin to speculate on whether this is time to be in cash, with the belief that their ability to time the market now will be the recipe for success as they avoid the impending downturn with the belief they can buy back in near the bottom.
Source: FactSet, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.
As at 31 January 2021
It is important to highlight the fact we retain the belief that investing in quality businesses with the ability to compound earnings over time will be the greatest contributing factor to any investment’s success and not market timing. It is necessary though to understand the risks currently associated with investing in equities at this point.
We are of the opinion that passive strategies now carry a significant amount of risk as you eliminate your ability to control exposure to quality assets and are now at the mercy of momentum / demand / and macroeconomics. What is often spoken about as the major benefit of passive strategies is the lower cost when compared to more active strategies, but in a market like we are seeing where there is such a vast dispersion between the top performing stocks and the tail, that outperformance of the market by active strategies now becomes compelling.
As an example, a UK investor that followed a low cost passive strategy focussed on domestic stocks (achieved through investing in the FTSE 100) would have underperformed our active strategy by more than 38% last year.
The Vanguard FTSE 100 UCITS ETF achieved -14.46% in 2020.
The BACCI Global Equity Fund achieved 24.52% in 2020.
If one considers a variety of ETFs, both general market such as the S&P 500 and the possibly something more exotic such as a Food and Beverage Europe ETF, both carry different elements of risk to which we would be unwilling to expose our clients in the active strategy. The top 7 shares in the S&P 500 now have a considerable bias to US tech stocks with the recent addition of Tesla, following a year of staggering gains. Not that you would have necessarily benefitted from this by owning the S&P 500 as it only became a part of the index as a result of the price appreciation. An obvious flaw in passive strategies.
The iShares STOXX EURO 600 Food and Beverage UCITS ETF has a 28% weighting to its largest position, being Nestle. The next two holdings of Heineken and Diageo mean that the top 3 holdings make up more than 53% of the ETF. Not to say that there is anything wrong with these companies but at this point in time, it is our view that it becomes more important than ever to understand the company-specific risks to which you are exposed, as this will dictate how you respond in a period of crisis.
Assuming you have done the work and understand the companies that you own, means you are more likely to manage the emotional selling that tends to be overdone during periods of instability. It also allows one to tactically increase positions as value is created.
So where to from here…
Whilst additional stimulus packages in a low-interest rate environment will continue to provide support for equities, we also feel the obvious lack of alternates make the stock market a more compelling alternate. You will pay to sit on cash positions in certain major hard currencies and the bond markets now carry an enormous amount of risk, as we are likely to experience some normalisation of interest rates going forward. For the return on offer this does not make sense. Global listed property is a widely diverse asset class with a multitude of subsectors, each with their own risk / return dynamics.
This is very neatly illustrated in the dispersion of returns shown in the graphs below at a sector level. Even following the major recovery during Q4 for sectors such as malls and hotels, the year was still a major disappointment with losses in the region of 30%.
Source: Catalyst Fund Managers & Bloomberg.
Returns are total returns in USD. Data as at 31 December 2020
Now more than ever it is important to understand in detail what you are exposed to with clearly defined risk and return objectives to ensure you respond appropriately to periods of increased volatility. As the world ground to a halt this time last year and GDP growth collapsed for just about every economy in the world, it seemed a sensible option to take a time out and sit in cash. This decision would have been extremely costly considering where markets are trading today. Whilst it does appear inevitable that markets will see a period of correction, this may not happen for some time due to the factors we have raised above. Provided your portfolio is appropriately positioned and structured around your personal circumstances, market timing is not a sport you should need to be involved in as it is most likely only going to result in additional frustration that could have been avoided.