John Leiper – Chief Investment Officer – 11th January 2021

This is the first blog since the holiday break. Whilst travel restrictions meant it wasn’t the holiday that had been planned, we adapted, and enjoyed the opportunity to spend some time together as a family and reflect on the last few months. That opportunity, to reflect, is important. I am lucky enough to have a challenging job I enjoy, that preoccupies a lot of my time and thought, and the space and resources with which to do it and for that I am thankful. Unfortunately, this is not the case for everyone.

Towards the end of last year, the investment team participated in Movember, raising over £1,100 in donations to help support men’s health. This year I have set myself a new charitable endeavour and over the next few months I will be running from Land’s End to John O’Groats, virtually. You can check my progress here and if you can, please feel free to support my efforts with a small donation, 100% of which goes to The National Brain Appeal. This fantastic organisation is dedicated to the diagnosis, treatment and care of patients with a wide range of neurological and neuromuscular conditions including multiple sclerosis, brain cancer, epilepsy, Parkinson’s disease, stroke, Prion disease and head injury. Everly little helps.

Returning to the theme of reflection, and the markets, I’m very happy with how the ACUMEN Portfolios have performed over the last year during a period of notable disruption. As we settled down into the new working routine, we found we could work remarkably efficiently from home devoid of the usual office distractions whilst retaining an extremely close working relationship. This is reflected in performance, particularly in the second half of the year. Since the 30th June, ACUMEN Portfolios 3-8 ranked 1st quartile across the board and within the top 16% of funds. The portfolios also largely outperformed their market composite benchmarks.

This strong performance can be attributed to several factors. The investment team itself has gone from strength to strength, which many of you may have noticed from the various adviser meetings and pre-recordings we have been putting out in conjunction with Steve McGregor and the marketing team. I think the upheaval also provided an opportunity to take stock, evaluate and implement a series of reforms as part of the broader strategic review we conducted across the business. Within the portfolios this involved reducing the number of positions and adopting a more Darwinian approach to our investment process. We also decided to move away from smart beta equity strategies. These aim to increase exposure to a number of investment factors but ultimately failed to deliver the kind of returns we’d hoped for. Instead of ‘outsourcing’ to such strategies, I placed greater faith in the team’s ability to select ‘winners’. I believe this decision is born out in the performance numbers. Another key theme has been our transition towards ESG, both within the existing ACUMEN Portfolios and via a series of new product launches completed in conjunction with the roll-out of the new Tavistock platform. There’s more to do, particularly to the protection portfolios, and I’ll be keeping you abreast of developments as they arise.

Another key theme has been communication. I first started writing these blogs in February 2020, so we are rapidly approaching one year. I’ve enjoyed doing so and the questions and debates these blogs have encouraged. Let’s have more of that in 2021.

With that in mind, and to continue on this theme of reflection, I wanted to highlight a couple of blogs from late last year that I feel have proven particularly salient over the last week.

In Life Imitating Art, published 6th October, I wrote:

‘Our strategic market outlook is more skewed towards a Biden clean sweep than the alternative scenarios, given our medium term forecast for a weaker US dollarsteeper yield curve and preference for ESG securities and emerging markets versus US equities..’

Then in Anatomy of an Election (so far…), published November 9th:

‘I want to flag a developing possibility, not yet priced into markets. Current consensus is for a split ticket between the White House and Congress. However, because neither Republican incumbent achieved 50% of the vote needed to win outright, Georgia will now hold run-off elections in January. If the Democrats can win both seats, the parties would tie 50-50 with vice president Kamala Harris casting the deciding vote, a de facto clean sweep.’

Fast forward to the first week of 2021… and these two paragraphs have aged exceptionally well. Setting aside the shocking and truly abhorrent scenes on Capitol Hill, Democrat success in the Georgia run-off was the election outcome we had positioned for and the removal of election uncertainty contributed to a decline in volatility and a rally in risk assets. Emerging markets rallied to a record weekly close, just surpassing the 2007 high, and with Democrats taking control of the White House, and both chambers of congress (a “blue wave”), we are likely to see further fiscal stimulus which should boost the reflation trade. Further, it increases the odds that Biden can implement some version of his energy policy which has boosted the appeal of ‘clean’ energy funds. Our overweight allocation to these themes has benefited the portfolios making it a very strong start to the year, with ACUMEN Portfolios 4 – 8 & Income in the top quartile IA sector and ACUMEN Portfolio 3 just missing out, but nonetheless ranked in the top 28% of funds.

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The most direct impact in fixed income markets was on the 10-year US Treasury yield which surpassed the psychologically important 1% level for the first time since the onset of the crisis. The “blue wave” narrative means we are likely to see further fiscal stimulus even if voting margins remain tight. This will likely include more coronavirus relief checks and greater infrastructure spending alongside close coordination between the Treasury and the Fed which is now actively promoting inflation given its renewed focus on employment and social justice objectives.

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With short-dated yields muted, the yield curve steepened, driven by long-dated Treasuries. The price of the iShares 20+ Year Treasury Bond ETF, which moves inversely to yields, is now back within its long-term channel and we forecast further losses should the economic recovery gain traction this year.

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We first used this chart in Nothing Is More Powerful Than An Idea Whose Time Has Come, published 16th November where I made the case for a rotation out of growth and into value and asked whether the dramatic moves we saw that month, triggered by news of a successful vaccine, reflects short-term trading behaviour or the start of a more meaningful rotation from coronavirus winners to coronavirus losers. I suggested that for the rotation to have legs we would need to see moderately higher bond yields, and that is exactly what we are now seeing.

In my follow-up blog, Is The Bond Market Smarter Than The Stock Market, published on the 25th November, I also flagged the US dollar, stating, ‘at the time of writing this index is at key technical support. Should the dollar break through this level it could catalyse the next leg of the ongoing rotation trade.’ Whilst the US dollar rebounded slightly on the Georgia election result, following Treasury yields higher, it remains below the referenced key technical level and we maintain our forecast for a weaker currency. Indeed, we’ve been calling for a weaker US dollar since One Currency To Rule Them All, published in April and again in This Time It’s Different in July (as a rule be wary of anyone who ever says this). We now have a new key level, demonstrated below in red. If we break through that, there’s another 5% downside before we hit the next potential support level in the mid-80s.

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Whilst the Georgia runoff helped catalyse the reflation trade, its roots are firmly grounded in our fundamental outlook. We originally wrote about The Return Of Inflation, in June and then again in August with Rising Phoenix. To summarise, we believe inflation will rise over time due to 3 structural factors:

  • Rising production costs due to ongoing deglobalisation and the reshaping of international supply chains
  • Policy resolution stemming from close and unprecedented coordination between monetary and fiscal policy to tackle the pandemic
  • Pent-up consumer demand given global savings rates have soared as the coronavirus caused consumers to delay discretionary spending

For these factors to have a decisive impact we need to clear the vaccine hurdle. All indications suggest the vaccine roll-out is progressing at pace, but the logistical challenge should not be underestimated and it already seems implementation may prove harder than anticipated just a month ago. Any set back, or further mutation of the virus, beyond the remit of the existing vaccine-suite, could therefore undermine this reflation / rotation trade.

We remain in unchartered territory and the first week alone suggests 2021 could prove just as volatile as 2020. The exceptional gains we’ve witnessed over the last few months has created possibly the largest ever disconnect between valuations and the underlying economy. That puts us in bubble territory – just look at Tesla up over 700% last year. But there is also the notion of a ‘rational’ bubble, given the huge levels of stimulus provided by global central banks which continue to prop up markets. So long as liquidity keeps flowing, and the coronavirus does not catastrophically mutate, markets will continue to brush off negative news flow and the path of least resistance is likely higher. This puts us at the start of a new cycle rather than the dying gasp of the last. The question to ask yourself, is how comfortable are you are with this notion of a rational bubble?

My feeling is that the coronavirus policy response has dragged forward future market gains. This has two effects: it reduces returns over the very long-term and it leaves markets extremely sensitive to any change in the prevailing narrative. We cannot ignore the apparent cyclical recovery, but we can’t take it for granted either. As a result, we have adopted a highly selective barbell approach that is subject to continuous review and monitoring by the team. On the cyclical side we have exposure to UK equities, US industrials, Brazilian and Russian equities, high yield debt and copper. At the same time, we have retained exposure to quality names and those highly profitable companies that we believe also benefit from longer-term structural tailwinds, such as Taiwanese and Chinese Technology firms and ‘ESG’ which we have implemented via the best-in-class iShares MSCI World SRI ETF. To summarise, we are participating in the recovery without overplaying our hand.

I would like to finish with the following chart which puts this topic into historical context. The white line in the top panel shows the ratio of S&P 500 cyclical sectors (equal weighted) relative to defensives. This has just broken through its long-term resistance level which could indicate further gains and additional upside to the S&P 500 which is approaching its long-term median level around 4,300. However, it is worth noting that the last time the ratio surpassed key resistance was during the tech bubble in 1999 and the break-out only lasted a few months. Excluding that, on all other occasions the ratio topped out with notable adverse outcomes for the broad index.  So, either this is the market top or it’s the start of a ‘rational’ bubble and equity melt-up. If you don’t buy into that just remember that ‘the market can remain irrational longer than you can remain solvent’.

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This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.