The US has dominated the start of 2021, with the explosive final days in office for the 45th President culminating in the Capitol riots, and then Joe Biden peacefully inaugurated as number 46. Donald Trump’s actions earned him the accolade of the first president in history to face the prospect of being impeached twice and while it will be interesting to watch any possible trial, these are hopefully the last vestiges of the non-stop noise around him that has dominated sentiment since 2016.
Market watchers are hoping Biden and his team can restore a sense of calmness and civility to US politics but their first hours in power showed a clear sense of urgency, with a flurry of executive orders undoing many actions from the previous administration: halting the travel ban from Muslim-majority countries, ending the national emergency used to justify funding a wall on the US-Mexico border, and signing an order allowing the US to re-join the Paris climate agreement.
New presidents tend to enjoy a spell of strong market performance and, on the surface, there seems plenty of news to spark a Biden bounce. Beyond the end of Trump, we have the announcement of a $1.9 trillion fiscal stimulus package, the Federal Reserve’s ongoing willingness to support markets, the President’s multilateral trade agenda and plans for stepping up vaccine rollout. For us, however, this speaks to the key question about US equities for 2021 and beyond; stock markets hit record highs last year despite the ongoing Trump melodrama and a global pandemic, so how much further is there to go?
To provide context for those market records in 2020, much of the performance of US equities overall can be attributed to a handful of large-cap tech companies (those FAANGs – Facebook, Amazon, Apple, Netflix and Google/Alphabet) that are now a dominant part of the S&P 500. As we all know, a large part of their success has come from relative Covid resistance, particularly versus more traditional consumer names, with the pandemic accelerating the global movement towards living more of our lives online.
Online penetration levels have risen sharply in the last year and we would expect some of the consumption patterns of recent months to persist post-Covid due to the increase in online literacy, even if there is a reduction from recent highs. However, we continue to believe performance from many of these stocks has been outsized relative to the opportunity: tech indices were four times ahead of the S&P 500 in 2020 and if you focus on just the 10 most-traded names, the so-called FANG +, this huge gap more than doubles.
We believe much of this share price growth has been driven by herd-like retail investing: the US government implemented generous stimulus packages during lockdown, including $1,200 for all citizens, and with plenty of free time on people’s hands, there has been a sharp rise in retail trading in the market. As a result, we are cautious on this sector and it is clear institutional investors increasingly recognise this risk.
Given such a backdrop, the question for us as asset allocators is whether these companies pose a systemic risk to US equities overall or will individually come unstuck over time.
Looking at broader points first, a Democratic government clearly poses increased risk of regulation and ligation against big tech, with handling of data, policing platforms and encouraging competition in all areas that may be targeted by policymakers. Whatever the regulatory background, market leadership also tends to change over time: only one stock (Microsoft) is among the US’ 10 largest today that was also in the top 10 in 2000 and we would expect the list of biggest companies to look very different a decade from now.
To be clear, however, we are not making sweeping comments about all tech stocks being in dangerous bubble territory; we are in a very different situation to the TMT boom of the late 1990s as many of today’s giants have considerable earnings and look in good shape for further growth. Where we do have concerns is when it comes to the ‘priced to perfection’ levels of many such businesses.
We have talked about a growing dislocation between market hope and economic reality over recent months and this is starkest in this particular part of US equities. We continue to believe it takes a major leap of faith to buy into these stocks at current prices, trading on multiples built on several years of future earnings. Given the path of many tech companies, it is hard to argue against them potentially achieving these earnings, particularly if they cut back on research and development – but the key thing to understand is that a huge amount can happen in three or five years, particularly in the face of Covid-19. This means investors are blind buying these stocks and if we continue to see market leadership shift to a broader base, as vaccines give greater visibility for the future, there could be further selloffs of the kind seen in September.
Another point to consider is that not all of them are actually technology stocks; of the six, Alphabet, Facebook and Netflix are consumer services companies and Amazon is consumer discretionary, leaving Apple (plus Microsoft, deemed an honorary FAANG) as the only genuine tech businesses. Although lumped together under the banner for convenience, this would suggest they have different drivers and are more likely to fall one by one rather than in some kind of sector collapse.
Tesla is also a consumer discretionary stock considered part of the tech sector but, if we were to highlight one company to be most concerned about, it would be this one. Many commentators have dismissed Bitcoin as speculation rather than investment over recent weeks – and, for the record, we would agree. But if you plot Tesla’s share price against Bitcoin over the last two years, the charts are not that different.
For us, Tesla encapsulates many of the concerns around ‘tech’, with a meteoric share price rise of more than 700% in 2020, fuelled by an army of retail investors. With a market cap of more than $800 billion at the start of 2021 (moving on rapidly from the chart below, created in December), the company is simply irreconcilable with other auto makers. While it is clear that Tesla has an edge in electric vehicles, changing regulations mean competitors are entering this market at pace.
When we look back at this point, our question is whether Elon Musk becoming the world’s richest man and Tesla the largest company ever to join the S&P 500 in December 2020 are signals of a market reaching its top, at least for certain businesses if not tech as a whole.
Given this situation, how are we currently looking at the US in our Multi-Asset funds and portfolios? Within our portfolios, based on long-term concerns about expensive valuation, the region has remained an underweight position and we have continued to favour cheaper areas including Europe, Asia and emerging markets. In the Multi-Asset funds, using our investment clock to aid tactical asset allocation, we have reduced exposure to growth in recent months, cutting our US position to neutral and increased our tilt to value and small caps.
Looking ahead to 2021, if we examine the earnings expectations across sectors, ex-tech offers many opportunities and we would expect investors to look at these undervalued areas as economies continue to improve. We have already seen early evidence of this, with fund ownership of technology decreasing for example and financials increasing.
Based on this, and while the switch from large cap growth to small cap and value are only short-term trends so far, we continue to see opportunities outside the US.
We are always looking to blend managers in any region or asset class to ensure adequate diversification. We tend to do this by holding core, value and growth managers and, at times, will introduce other funds where we have high conviction, such as small caps for example.
As we are at the beginning of a new bull market, we expect a pick-up in growth and economic activity this year. We have therefore increased exposure to small cap equity in the US as smaller companies tend to perform better during a rebound than larger peers. This is due, in part, to the fact they have a more domestic focus and will benefit more from increased consumer activity. A favoured holding in this area is the Artemis US Smaller Companies Fund.
- The fund has been headed up since launch in October 2014 by Cormac Weldon, who moved from Threadneedle with his team earlier that year. He has spent his whole career covering the US, which we see as a major plus. We like to invest in funds with a long and consistent track record and it is important to have managers who have remained in place since launch wherever possible. Artemis is renowned for having a very attractive remuneration structure, which enhances managers’ motivation to deliver performance. We also believe this is a key factor in low manager turnover at Artemis.
- One element of the process that fits with our philosophy is a focus on downside protection. Smaller companies can carry an extra layer of risk as they tend to find it difficult to access finance in periods of market stress. Investing in a small cap fund that conducts detailed business and financial model assessment, and also looks to get comfortable with company management, provides us with an additional layer of reassurance. The Artemis team does this as they want to thoroughly understand the downside case for any investment they make.
Given the strong performance of growth managers in the US, we have been reducing our exposure. As outlined earlier, we acknowledge a small subset of companies look very overextended and many of these are likely to face increasing headwinds as regulations target the tech sector. That said, there are still opportunities in the region given the strong earnings expected across other areas as vaccine rollout continues and market leadership broadens, and we are accessing this via the AB American Growth Fund among others.
- The manager of this fund – Frank Caruso – has been at Alliance Bernstein for over 28 years. He is supported by two portfolio managers and seven analysts and, again, the retention rate at this company is excellent. They have a structured process and are very specific about the criteria used to identify companies; this is an important feature as we want the funds we select to deliver exactly what we expect of them whatever the market backdrop. Consistency of process should, in theory, lead to consistency of style and these are elements we monitor when we review our holdings. Caruso and team focus on companies with a persistently high return on assets but they are also looking for positive earnings growth and earnings revisions. Again, this emphasis on companies with balance sheet strength helps the fund protect on the downside.
- We also like their disciplined approach to valuations. If they do not like a company's valuation, they will not hold it and, as a clear example of this in practice, the fund is currently underweight technology. They do not own Apple as the fundamentals and valuations are at odds with their investment philosophy, with Tesla excluded for the same reasons.
Value has struggled relative to growth, with the differential between these styles exacerbated last year as many companies were forced to cut dividends as a result of seeking government help during the pandemic. Value tends to do well as conditions recover following a recession, however, which is typically dubbed the reflation trade. As a result, we expect our value funds to play a bigger part in our performance over 2021, including JPM US Equity Income.
- Another long-term manager, Clare Hart has been at the helm of this fund for over a decade and has been at JP Morgan since 1999. One of the attractive elements of investing with JPM is the abundance of research at their disposal: they have tremendous depth in terms of equity analysts, which gives fund managers detailed knowledge of the companies in which they invest. The long tenure of team members is testament to a remuneration structure that rewards loyalty over time.
- We like the consistent approach to process that Hart and team provides, as it delivers a clear picture of how and when this fund will perform. They like to invest in strong, profitable companies and focus on stocks with above-average dividends that can maintain these distributions over time. This attention on quality and stability lends itself to downside protection. We also like the fact the fund is overweight financials and underweight technology, as this fits our valuation view at present.
As US earnings start rolling in for Q4, one feature of note, so far, is the level of upside surprise in the reported numbers. Companies are reporting better earnings than expected, and this is another reminder that it is never easy to anticipate what the future holds. For this reason, it is always sensible to have a good core fund in your line-up and we believe BlackRock Advantage US Equity fits the bill.
- This fund is different from the others mentioned, as, in a sense, it is less about the team and more about the machine. Quantitative strategies are becoming increasingly more sophisticated, helped by improvements in technology, which means funds can now incorporate big data and machine learning.As an example, this fund from BlackRock uses alternative data when assessing companies. It can draw on mobile app usage, foot traffic measured by GPS, web traffic and credit card spending data – and all this provides a much more in-depth view of companies.
- The eagle-eyed will note the fund only has a short track record but the strategy had been running for more than a decade before launching in the UK back in 2018. This is a good example of where we will do the extra work necessary to assess a fund. We also like the fact the team has been given the necessary resources to obtain big data feeds and implement machine learning capabilities.
KEY RISKS
Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well-regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.
DISCLAIMER
The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.
