As another financial year has come to an end, one that has seen unprecedented volatility, I thought I’d pen some thoughts today on what I see ahead in the new financial year.
I’ve been in this game long enough that I remember I was quite excited when I started writing strategy about FY00, a good two decades ago. How time flies but the basics of sensible investment don’t change.
I fully understand the two major concerns people have. A second wave of COVID-19 leading to further shutdowns of the economy and US-China relations further deteriorating in a US Presidential election year.
As Morgan Stanley’s global head of macro strategy Matt Hornbach notes: “One word comes to mind when most investors consider prospects for the V-shaped recovery: Doubt. Investors aren’t alone in this assessment. Most politicians and central bankers around the world share the concern….”
This investor doubt fits, psychologically, into the “Early Stage Recovery” phase of the market cycle. Perceived scarcity of “abundant bargains”, due to central bank action, only exacerbates the doubt. The V-shaped recovery we expect should help investors transition into a mid-stage bull market mindset for risk assets by year-end.
However, these “doubts” are widely known, expressed by record cash levels and the chart below.
Yes, S&P 500 Index futures net shorts are the largest in nine years. This downside hedging is done by professional money managers and also clearly expresses their “doubts” about the sustainability of this rally, let alone it continuing meaningfully higher.
Similarly, many prominent investors have expressed their bearishness publicly which potentially suggests their lack of exposure to this recovery.
Quite frankly, it’s been the shortest “bear market” in history, around 5 days, and yet there is very, very little public bullishness except for the odd-day trading Twitter commentator and my old friend Peter Switzer.
While the doubts linger, the data has been coming through stronger.
Morgan Stanley’s Global high frequency activity tracker: “The recovery is broadening out: Over the last two weeks, there has been a more broad-based improvement in growth trends around the world. More economies have now joined in the recovery and more indicators within each economy are also improving. High frequency indicators suggest that we are seeing a further acceleration in growth in June as compared to May.”
Indeed, the Morgan Stanley Business Conditions Index continued its rebound in June, rising 35 points to a level of 87, its highest level since September 2009. Although labour and capex measures remain soft, more than three-quarters of analysts in this survey are now reporting improved business conditions.
And, these charts are becoming more familiar. See Philly Fed print as one example below. Notably, Morgan Stanley’s June ISM tracker sits at 53.1 (vs consensus 48.5) – above 50 for first time since Feb.
Morgan Stanley think that this cycle is more normal than appreciated. Weak-but-improving data, light positioning and risk premiums are all supportive, but especially for many strategies that have historically worked after the lows in economic data. Recent upside surprises in economic data give us continued optimism around a V-shaped economic recovery.
Arguably the more pertinent question to ask yourself about the new financial year is ‘am I too bearish?” What if we do see a V-shaped economic recovery that drives down the most lagging of lagging economic indicators, the unemployment rate?
Under that scenario equities will beat EVERYTHING and all those hiding in cash and shorts will be the underperforming materially as we have seen since the March 23rd lows.
You can also see that despite upticks in COVID-19 cases in some jurisdictions, governments are moving forward with opening their economies. I personally highly doubt it’s possible to head back into full lockdown and get compliance from the population.
Secondly, you also saw clear evidence President Trump DOESN’T want another fight with China that in any way drags down Wall St. He very quickly corrected statements attributed to his team when US equity futures were down -2% in Asian trading. The President’s tweet saw US equity futures recover to be up.
With the monetary and fiscal taps turned fully on, the world starting to reopen, economic data recovering, and the likelihood of a COVID-19 vaccine being developed – what do we do with portfolios?
My view is you never move away from the highest quality structural growth stocks globally, such as my largest investment Microsoft which is currently at an all-time high over US$200, yet at the margin if I am deploying cash I am tilting/rotating it towards super high quality companies with a more cyclical element.
In a global context that means adding to consumer facing names such as Nike, Coca-Cola Company, Heineken, Mastercard, and Berkshire Hathaway, while trimming a little of stay at home winners such as Amazon and Netflix which have been wonderful for our portfolio over FY20.
I don’t believe in growth or value as such, I believe in investing in quality, and quality can have different attributes and leverages to an economic cycle.
In an Australian context I want to reiterate what I wrote a few weeks back. [1]
“If I ran Australian money I would be increasing my holdings in all four large cap Australian banks (ANZ,CBA,NAB, WBC), increase my holdings in discretionary retailers, led by Wesfarmers (Bunnings), JB Hi-Fi (JBH), Harvey Norman (HVN) and even Scentre Group (SCG) as people will return to shopping malls.
The final sector I would increase my holdings in would in those will exposure to would be those with exposure to infrastructure construction. Those include Seven Group Holdings SVW (Caterpillar, Coates Hire, 10% stake in Boral), Boral BLD itself before it exits its trouble North American business and becomes a pure play Australian exposure, and Lend Lase LLC… Perhaps it’s time to sell the defensive infrastructure play Transurban (TCL) to fund rotation to cyclical infrastructure construction plays.”
All the Global and Australian businesses I mention above have high quality, high barrier to entry assets and will re-rate as we see evidence of economic recovery.
I’m optimistic about FY21. The previous financial year, while volatile, has seen solid double-digit returns generated by investing in a concentrated portfolio of high-quality global equities. We have positive momentum as we enter FY21 and I believe you will see that positive momentum lead to a broadening of the equity rally to include high quality cyclicals.
Right now, investors have record cash levels and there’s the largest short position in S&P500 futures since the GFC. We also have record low interest rates, record money printing by central banks and record government fiscal stimulus. The world is being flooded with liquidity.
Imagine what could happen if a COVID-19 vaccine was discovered under the settings above? Yes, market melt up.
Equity markets look forward and I think they’re right in looking through the worst of the COVID-19 economic and earnings impacts and focusing on the brighter future that most likely lies ahead.
Let’s see what comes, but I agree with Peter Switzer and Morgan Stanley: buy the equity market dips when they come and tilt a little towards cyclicals while never compromising on quality.
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