We have identified our top six themes with which to base your investment in the coming year.
Theme 1: Staying Invested in Risk Assets
The base case macro scenario for most global fund managers is favourable to risk assets. This scenario is not without risk given the strong rebound in global markets since March. More corrections and volatility are possible but if a post-pandemic, globally-based, broadly supported cyclical bull market unfolds, it makes sense to maintain an overweight stance to equities (which after such a rally is never an easy task). Investors are also forewarned that volatility (and the likelihood of correction) is likely to increase going forward. But this will be the price to pay to stay allocated to equities. As it has already been well documented, timing the market is a very difficult and potentially costly task. As shown on the chart below, investors who stayed invested across the full cycle sharply outperformed those who unfortunately missed market recovery phases as they stayed on the sideline for “safety” reasons.
# Theme 2: Return Of The Underdogs
We have been through an extraordinary period of value factor underperformance over the last 15 years. There were only two periods of extreme divergence in style performance over the last 30 years: the “Tech Bubble” (growth outperformed sharply between 1994 and 2000) and the pre-GFC (Value outperformed sharply between 2000 and 2008). Historically, a brutal style rotation took place in each of the two previous extreme periods (see chart below).
But after a very long period of underperformance, the value style has made a slight comeback. The one common thread is that both value and non-US equities have both been underdogs. What the recent outperformance of value and non-US equities shows us is that professional equity investors are increasingly uncomfortable overpaying for arguably crowded trades, whether from a style or regional perspective, and are ready for a change. They just need a trigger.
For this return of the underdogs to continue, we need a cyclical improvement in global growth which is the base case scenario for 2020. As of now, the key risk for investors would be to fall into a “value trap.” i.e value stocks get even cheaper as fundamentals continue deteriorating.
# Theme 3: Brexit Boost
After four-and-a-half years of Brexit uncertainty, the UK could finally be set for a relative-performance rebound. Indeed, the Sterling, the UK equity market and UK property have all been out of favor since the referendum vote for Brexit in June 2016. Now a trade deal has been struck between the EU and the UK. This could lead to a significant improvement of investors’ sentiment towards the UK heading into 2021. Sterling remains undervalued and could well recover to the US$1.40 rate. UK equities are cheaply valued, both in an absolute sense and relative to government bonds – where the gap between equity and bond yields is the highest since World War 2. UK small cap companies are also cheaply valued relative to large cap companies as they trade on a forward price-earnings multiple of 11x compared to 12.5x for large-caps.
# Theme 4: Green & ESG Investing
Tackling climate change has moved to the top of the government and corporate agendas around the world. Acceptance of the fact that greenhouse gas emissions cause global warming and that these need to be curbed will become (almost) universally accepted. The realization that action on climate change is needed is rapidly moving into the mainstream. A big theme for 2021 will be more spending on green initiatives.
Indeed, emissions of greenhouse gases will need to be cut significantly if global warming is to be restricted to 1.5- 2.0°C. Carbon dioxide (CO2) emissions from burning fossil fuels account for almost two-thirds of global greenhouse gas emissions and are the most immediately practical to control. A switch from fossil fuels to solar and wind energy, investment in carbon capture and storage technologies and a phasing out of subsidies on fossil fuels will be the key elements. The latter amount to as much as US$5 trillion (6% of global GDP) and is the largest in emerging economies. We think that Europe will be at the forefront of this green move in 2021.
From an investment point of view, the companies best positioned to manage the risks and capitalize on the opportunities associated with climate change are of two basic kinds:
- Those providing services and solutions to help others reduce emissions and increase energy efficiencies, and
- Those more adaptable and resilient companies working to “future-proof” their business models by reducing emissions and resource use faster than their competitors.
# Theme 5: Gold and Bitcoin as currency hedges
Central banks from the Fed to the ECB to the BOJ have told us they will keep policy very easy for 2021 and likely well into 2022. This policy has under the surface, started to a risk of a crisis of confidence in fiat currencies, including the dollar. In 2020, Gold and Bitcoin both saw significant gains as the US dollar fell. We view these two assets as the ultimate portfolio diversifiers to the further money printing (and risks for a “hyper-inflation” scare).
Indeed, traditional currencies, be it the US Dollar, Euro, Yen or Pound are all inflationary in nature, due to the very fact that central banks can print them at will. This means that fiat money is losing value every day as its purchasing power is reduced. One of the most common hedges against inflation is gold, due to its limited supply and scarcity. Even though gold is not an ideal investment (no earnings and no dividends), it does retain value better than fiat currencies and is fairly tradable.
Bitcoin shares many of the characteristics of gold, most notably that it is a scarce and limited resource. There can only ever be 21 million Bitcoins in existence and not a single coin can be created arbitrarily — this makes Bitcoin a deflationary currency, theoretically increasing its purchasing power every day.
Bitcoin also has some key advantages over gold:
- It can be held, moved and managed easily and cost-effectively
- It can be traded or exchanged almost instantly
- It virtually crosses all physical and geographic boundaries
- It can be spent effortlessly in daily use
However, Bitcoin’s volatility is a major factor which cannot be ignored. As such, any investment in bitcoin as a portfolio hedge should be limited to a very small percentage of a global portfolio.
# Theme 6: China Equities
China is proving to be one of the biggest beneficiaries of the upsets of 2020. The country has seemingly handle the outbreak of the coronavirus better with very few months of lockdown when contrasted to the RoW and now Donald Trump is out of the White Hoouse, leaving a much friendlier Joe Biden as President. The deep value on offer in Mainland China and Hong-Kong stocks offer investors upside potential.
The inclusion of A shares into the MSCI regional benchmark is a very important milestone, as it is “forcing” international investors allocating to mainland Chinese stocks, which is becoming an asset class by its own. From a cyclical perspective, we believe that monetary easing, accelerated infrastructure investments through fiscal easing and some fine-tuning on local property purchase restrictions will drive a profit recovery in 2021. When it comes to offshore equity, the expected rotation from growth to value might benefit China which is by itself a value trade. The opportunity in China can be split in two. First, the “old economy” names would benefit from a stabilization of economic growth and they trade at attractive valuations. The second is within the “new economy” – indeed, the internet, healthcare and consumers names benefit from secular trends such as e-commerce, aging demographics and consumer upgrade. The recent experience of Ant Group and Alibaba shows that investing in Chinese growth is not without the risk of government intervention.
Social tensions continue to be an issue for Hong Kong, which faces an existential crisis in its international identity. The opportunity is if a lot of these ‘social’ concerns seem are already priced in. The Hang Seng Index is trading at 10x forward price/earnings, which is close to its historical low (see chart below). Meanwhile, the social tension has recently shown some signs of abating, although visibility remains low. The Hong Kong stock market is comprised of roughly 70% offshore Chinese companies and 30% domestic Hong Kong companies. While the former should benefit from a more favorable macro policy backdrop in China, the domestic Hong Kong companies are facing the headwind of an economic recession in the city. For it to prosper once again, Hong Kong needs to show it can benefit in different ways from its closer allegiance to China, perhaps I part via more big Chinese company listings.
Thanks for reading and good luck investing in 2021!