Global stock markets have continued their upward march since our last market commentary in April. When compared to the darkest days of March 2020, the US S&P 500 stock index has now doubled in value and broadly similar, albeit slightly less impressive, figures are being witnessed by other key market exchanges.
The effectiveness of leading vaccines has largely been confirmed by the data. Covid-19 fatality rates have been vastly reduced in recent months whilst the risk of transmission throughout the population has also notably faded.
Not only is this encouraging in itself, but governments have collectively, for the most part, responded by getting their acts together rolling out supplies across the globe, no doubt incentivised by the financial prospect of a return towards economic ‘normality’.
This positive vaccine picture gives us greater confidence that the worst might be behind us. Of course, we must not forget that no vaccine is 100% effective and further mutations and variants could yet change the picture. However, the facts would suggest that a light can now be seen at the end of the tunnel as far as economic – and hopefully daily – life is concerned. Inevitably there will be winners and losers from the changes brought to the world. For example, commercial property landlords might face new pressures from changing work and shopping habits, but it would appear that ‘business as usual’ is getting closer.
Notwithstanding the progress made in taming the virus during the first half of the year, a defensive rotation was simultaneously taking place beneath the surface in financial markets. Inflation fears (prevalent in January and February) receded almost as quickly as they prevailed! Related rising bond market rates retreated following a brief but aggressive rise. For example, US 10-year Treasury yields rose from sub 1% in late 2020 to almost 1.8%, before falling back down to 1.27% at the time of writing. UK Gilt yields followed a similar pattern. Such examples of market zig-zags in the short-term confirm to us the importance of not losing sight of the longer term picture.
As economic growth expectations weakened and inflation fears petered out more recently, some of the shine was taken off a chunk of the recovery trade. Consequently, Value, Commodity and Smaller Cap shares stalled in June as market participants looked for shelter in larger, ‘safer’ Growth stocks with greater structural prospects (but also with greater price tags).
Less aggressive economic growth forecasts might also serve to provide an important extended signal that the zero interest rate punchbowl might not be taken away any time soon. This is important when considered alongside the enormous global debt pile that has ballooned as a result of fighting the pandemic with economic stimulus. With such a large debt mound to work through, it is inconceivable that policymakers would wish to raise their own financing costs. With reopening prospects looking rosier, that seemingly offers something of an extended set of ‘Goldilocks’ conditions (not too hot, not too cold, but just right) for a little longer yet – hence explaining the continued sugar rush dynamics.
We have written several times that we feel some areas of global stock markets appear excessively valued, matched only by the degree of their popularity. In particular, US Tech/Growth names fit the bill, with these forming a large proportion of major US indices (circa 30%). Furthermore, the US stock market itself now represents nearly 60% of global stocks by value (roughly doubling from the level of a decade ago). This has been fuelled by the increasing popularity of the ‘FAANG’ Tech stocks, ESG (Environmental, Social, Governance) trends driving money into the same stocks, a shift toward passive investments that track the largest global stocks and momentum trades. All these are providing a wall of money that appears less concerned with elevated valuations, but that continues to extend this trend further still. Bearing this in mind, we continue to exercise caution with regard to areas of extreme popularity where we believe high valuation levels might come to pose a concern at some point. But until then, the music continues to play and everyone is up dancing.
The FTSE 250 Mid Cap index and UK Small Caps have surged over the past six to nine months since the recovery trade switch was flicked. Sterling assets are starting to get noticed again now that the worst of the Brexit uncertainty appears to have passed. The FTSE 100 index has fared well, albeit less spectacularly than its younger siblings. European stocks, which are more geared to global economic recovery, have also started performing over the past six months or so.
All in all, markets are continuing to absorb good news, but we remain aware that much complacency seems apparent with regard to high valuations in general. Much of this is due to the assumption of low interest rates for the foreseeable future.
The damage that unexpected inflation could cause to both components of a classic 60/40 Equities/Bonds portfolio is never far away from our minds. Should such a scenario prevail, we believe our more rounded exposures to portfolio construction and consideration of many of the historical drivers of long-term portfolio returns, could provide a greater shelter from such forces, as well as possible beneficiaries in many cases eg Commodity stocks, Value, Gold, Absolute Returns.
Ultimately, we will continue to manage your investments with discipline and without distraction in what we believe to be the most appropriate style – leaning into areas where we see value and exhibiting caution in those where we feel such a stance is warranted.
The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.