by Joy Yacoub, Executive Director of Pengana Capital’s International Equities range of funds.
It would not be unfair to say that this has been a challenging year. Consider a global pandemic, economic devastation from the shut-down of a global economy, the deepest recession since the 1930s and record highs for the U.S. equity market. Throw in the upcoming and well documented U.S. election and the uncertainty investors are facing alongside market volatility is almost unprecedented.
Understandably, some investors are concerned about the pros and cons of a Trump vs. Biden presidency. A democratic sweep would almost certainly mean a rollback of Trump’s massive corporate tax cuts – a negative for stocks. But the additional economic stimulus – which the market apparently loves, despite the deficit implications – and returned stability on the China trade front would be a big positive. It is important to emphasise that we are always faced with uncertainty, and both short and long-term disruptors. It’s just that sometimes these disruptors become more amplified.
If we step back and take a closer look at the last three months, by the end of August the S&P 500 had delivered its strongest 5 month return since 1938 – shortly followed in September with the fastest technical correction sell-off of the NASDAQ in history. But despite the intra-quarter volatility, the outcome was a repeat of most quarters of the last five years and the broad market finished up at 3.9% (30 September). What is most astonishing here, is that it was seven large cap US companies (Apple, Tesla, Amazon, Nvidia, Facebook, Salesforce, Mastercard, AMD) that accounted for almost 50% of the total return for an index composed of 3000 stocks.
What we do know, is that extremely loose monetary policy from central banks – that adds trillions of dollars of liquidity – combined with ever-rising and potentially unmanageable debt levels on every balance sheet, from consumers to governments, has created an unnatural situation for capital markets. This environment is one where investors are faced with few alternatives for allocating their capital. And in a small field of few choices, it seems equity markets still offer some relative value.
On an absolute basis, we believe equity markets in the US (and in particular large companies) are expensive. Our assessment is that these the FAANG and Microsoft stocks are priced for perfection while also mounting risks. The US House of Representative’s antitrust subcommittee study into FAANG and Microsoft practices has brought to light some allegations, including accusing Amazon of monopoly power. In Europe, the European Commission announced it will make more use of injunctions against big tech companies to change their alleged anticompetitive practices. Challenges are also coming from commercial interests such as Epic Games (publisher of Fortnite) filing antitrust lawsuits against Apple and Alphabet over their app store policies. While we believe these risks are manageable, we simultaneously believe they are not reflected in the share prices – hence we no longer hold any exposure to the FAANG and Microsoft stocks. However, given the alternatives (cash, bonds etc), an argument could still well be made to own these stocks. Our strong valuation discipline prompts us to look elsewhere and we have been finding growing businesses at better prices.
Looking ahead
Over the coming months we see the potential for further heightened volatility and a drawdown in equity markets. We believe risk and return need to be managed together to achieve the best outcomes for our clients and this is why active portfolio management and a strong conviction is crucial. We have chosen to position away from “crowded” companies and address the rise in uncertainty. When rising above the risks, it’s important to make sure we invest in businesses with great management teams that are growing through market share or innovation, and have positive tailwinds helping them through disruptive periods.
Some of the positive tailwinds behind our holdings in the Fund include:
- An ageing demographic trend. Companies like Novo Nordisk, Medtronic and Biotelemetry.
- Emerging market consumption growth. finding investments that may benefit from a middle-class population growth such as Bharti Infratel and Airtel as well as Chinese gaming and e-commerce companies like Tencent, DouYu and Nexon and
- Green economy examples like those in plastic replacement and green buildings such as, SIG Combibloc and Stora Enso as well as renewable energy players like Vestas.
To address market disruption, we have invested in companies that would potentially benefit from heightened market uncertainty and the rise in volatility. For example, the quasi-monopolistic exchanges like CME, Deutsche Bourse, and market makers like Flow Traders who benefit from increased trading activity.
We maintain a long-term outlook when investing, and these are some examples of the long-term growth tailwinds that are helping many of our holdings sail smoothly through the various choppy waters that undoubtedly lie ahead.
