Market Update: 3 December 2020

As the end of a turbulent 2020 nears, this update is an explanation of how and why the flagship global equity portfolio is currently positioned as it is.

We are nine months on from the largest economic contraction in 90 years, parts of the market (best illustrated by growth stocks) have had a huge rally, however, over the past month, triggered by the news of a successful vaccine, we have seen a strong rotation into the more cyclical areas of the market. This raises the question of how best to be invested now.

To explore this, it is worth considering two scenarios:

1. The first scenario is the status quo i.e. more of the same. Since the intensification of the US-China trade war in 2018 we have had a bias to slowing growth, low inflation, and the rate-hiking cycle of 2017 was paused and moved to cuts. The COVID-induced recession has reinforced a view that this scenario will persist far into the future. The outcome is that growth stocks have been in huge demand from investors. This is the current trend in markets, and we have to be open to the fact that this trend could persist.    
2. The second scenario is to acknowledge that we have had a major shock and are now in an economic recovery. As our economies re-open with a flood of stimulus behind us, this recovery could be quite powerful. Historically, from this point in the cycle, the best returns would be expected to come from cyclicals - the companies directly benefiting from that recovery. This would represent a break in the current trend.

The reason an investor should consider the latter case is driven by three factors:

1. The data is consistently better than expected and looks to be accelerating.

The data shows the speed and the strength of the economic recovery is much better than we would have ever expected in March. In the USA, we can look at the cornerstones of the economy:

• The US housing sector is booming – prices are rising with construction and activity levels booming too. There has been a V-shaped recovery in housing starts and existing home sales.
• US auto sales (another big ticket, high-confidence item) are also experiencing an immediate V-shaped recovery.
• US retail sales are well above pre-COVID levels.
• The activity is flowing through to jobs. US unemployment is now 6.9%. For context, during the global financial crisis (GFC), US unemployment roughly doubled from 4.5% to 10%, then took four years to fall back below 7%. 2020 saw it rise from 3.5% to 15% to below 7% in the space of six months.^[1]

China is the other huge economy, and major data points show it is also in good health. Retail sales and industrial activity have rebounded, auto sales are now running 8% higher than pre-COVID levels, and domestic air traffic volumes have fully recovered. ^[2]

This picture of global recovery is expressing itself in commodity prices. For example, copper is at its highest price for seven years and US steel prices have doubled. The shape and speed of this recovery is very different to the GFC. ^[3]

2. Supporting the recovery is a different fiscal and credit environment vs. the past.

Currently, we have accommodative monetary policy, record global fiscal spending and the banking system willing and able to lend. This is a different environment post the GFC, where fiscal policy was reversed (recall the shift to austerity in Europe) and the banks were reluctant to lend, instead preferring to reduce the size of their loan books.

The longer-term question is how long this new attitude towards aggressive fiscal spending to restore full employment lasts. While fiscal actions are by their nature more political and unpredictable, we suspect the direction will be towards this becoming a more permanent feature. Recall that quantitative easing (QE) and zero interest rates were first considered highly aggressive and unorthodox monetary policy before becoming normalised and now “permanent” features of the landscape today. QE and zero interest rates provided a huge tailwind to certain assets over the past decade. A change in fiscal approach could alter that course, and more importantly, alter the beneficiaries.

3. A successful vaccine changes the path we have been on.
 
From a growth perspective, a successful vaccine allows the full release of labour back into the economy and importantly, gives businesses the confidence to plan for the long term.
 
From an investor’s perspective, a successful vaccine really removes the left tail of very negative outcomes for the real economy and markets. We can draw parallels to other times in markets where we have had similar risk reduction events – US Federal Reserve stress tests in April 2009 put a line under the banking system, while the European Central Bank’s Mario Draghi’s “whatever it takes” pledge in 2012 removed imminent euro break-up fears. Today, the vaccine should be the tool to move us past the “open” and then “lockdown” dynamic. The situation can always play out differently, but these events have usually been very good for risk assets.

Putting this together, and combining it with the fact that recovery stocks are where we believe the majority of relative value lies in market, it makes sense to have meaningful exposure to this second scenario.

In constructing the flagship global equity portfolio, we are essentially weaving these two scenarios together.

We want to own stocks where there is value and a direct benefit from the recovery, but there must be something more - there must be a growth driver that will drive earnings, should the recovery take longer or be weaker than expected. There must be more than mean reversion.

In a similar fashion, we are happy to own businesses in the quality growth mould that are benefiting from long-term changes, but are focused on identifying tomorrow’s growth companies that are not being priced as such today.

Key components of the flagship global equity portfolio

• 20% in Growth Industrials. These stocks are recovery beneficiaries but also have strong long-term stories e.g. Carrier, FedEx and Indian truck-maker Ashok Leyland.
• 16% in Semiconductors. These holdings are powered by three major themes - investment in cloud infrastructure, internet of things (IoT) and 5G.
• 14% in Travel-related stocks. Acquired during the peak of the COVID lockdowns, our holdings have begun to perform strongly post the positive vaccine data. We believe many of these businesses will go back to being viewed as ‘quality growth’. Examples include on-line travel agents like Booking.com, or the Chinese leader Trip.com.
• 11% in Chinese consumer stocks. Examples include Ping An Insurance, AIA and Li Ning.
• 8% in Healthcare stocks. The portfolio has benefited from positive news on a COVID vaccine and therapeutics over the course of the year and we have recently trimmed our exposure on valuation. Takeda remains a key holding.
• 6% in Internet-related stocks. We have significantly reduced our exposure from around 14% in August 2020, as the strong prospects of the companies we owned are increasingly well-expressed in their prices.

In summary, it is increasingly clear that we may be on the cusp of a significant change in markets after a long trend, and if so, we expect there will be a change in the kind of companies that will likely benefit. With our portfolio tilted towards these, the stock price moves in November give us a sense of what may lie ahead should this continue, but above all, it shows the benefit of diversity of approaches for different conditions. 

^[1] Source: Housing Starts: Seasonally adjusted annual rate, FactSet (to 30 September 2020); Auto Sales: Seasonally adjusted annual rate, FactSet (to 30 October 2020); Retail Sales: FactSet (to 30 October 2020); Unemployment rate is U-3 seasonally adjusted (to 30 October 2020), Source: FactSet.
^[2] Source: Retail Sales: FactSet (to 30 October 2020), Auto Sales: FactSet (to 31 July 2020), Travel: FactSet (to 30 October 2020).
^[3] Source: Copper: High Grade Copper (NYM $/lbs), FactSet (to 30 October 20); Steel: U.S. Midwest Domestic Hot-Rolled Coil Steel (CRU) Index (NYM $/st), FactSet (to 27 November 2020).

DISCLAIMER: This article has been prepared by Platinum Investment Management Limited ABN 25 063 565 006, AFSL 221935, trading as Platinum Asset Management (“Platinum”). This information is general in nature and does not take into account your specific needs or circumstances. You should consider your own financial position, objectives and requirements and seek professional financial advice before making any financial decisions. You should also read the relevant product disclosure statement before making any decision to acquire units in any of our funds, copies are available at www.platinum.com.au. The commentary reflects Platinum’s views and beliefs at the time of preparation, which are subject to change without notice. No representations or warranties are made by Platinum as to their accuracy or reliability. To the extent permitted by law, no liability is accepted by Platinum for any loss or damage as a result of any reliance on this information.