Looking for the best investment return may be the bane of an investors’ life at the best of times, but the start of each year brings a fever to this quest, with almost everybody focusing on how to structure portfolios for the year ahead. Or simply put: Where will I make money this year?
An invitation from Anchor Capital to an online presentation titled ‘Where the money will be made in 2021’ therefore immediately attracted my attention. Is there still money to be made, considering all the bad news and uncertainty that nonetheless sees markets at record high levels?
Henry Biddlecombe, investment analyst at Anchor Capital, immediately tackled this anomaly, saying that it’s fair to say that most investors are suffering from a certain level of cognitive dissonance.
“Our experience on the ground doesn’t match up with what we’re seeing play out in the markets,” said Biddlecombe right at the start of his presentation.
“On the ground, we’re bearing witness to job losses, we see business failures, we are living under lockdowns, and economic data isn’t looking great. On the other hand, the market is reaching all-time highs.”
Extremes in sentiment
Worldwide, investors have noticed that the shares of any technology company have increased dramatically.
“The tech sector has been the standout contributor to the market’s performance over the last year,” says Biddlecombe. “The physical economy has been left behind, especially on a relative basis.”
He describes the two extremes in the market as a barbell “made up of instances of excessive pessimism on the one hand, and on the other end instances of unfounded optimism”.
Everyone has seen how quickly the market recovered from the lows of early 2020. At the same time, most people also realise that although the market has recovered at an index level, it is not comparable to the market a year ago.
Although Biddlecombe’s presentation was focused on the US economy and investment markets, the performance of the US at this point is undeniably important for all economies.
Tech sector on fire
“There have been some pretty material shifts underneath the index level, which are important to take note of,” says Biddlecombe, noting that “the tech sector and initial public offerings are on fire”.
He mentioned a few examples of this market exuberance – borrowing that ominous phrase from former US Federal Reserve chair Alan Greenspan. The first is that the S&P index is very high with its historic price-earnings ratio the highest in 50 years.
His analysis of the weight of tech companies in the S&P 500 index and their performance over the last 12 months shows that these (information technology and communications) companies produced more than three quarters of the total market return last year.
“Why is the market capitalisation of Tesla, which manufactures some 500 000 vehicles per annum, more than that of General Motors and Ford together? And the run in bitcoin?
“We have seen a massive return in speculation. Option trading has exploded this year,” says Biddlecombe, adding that there is an unusual high appetite for risk.
Tesla CEO Elon Musk recently made reference to Tesla’s high share price. When the price increased to make him richer than the other tech billionaires, he warned that the share price creates high expectations and “could get crushed like a soufflé under a sledgehammer”.
Interest rates key
Biddlecombe says in his presentation that the main reason for the increase in speculation and the run in share prices is simply that interest rates are essentially zero.
He identifies the outlook for interest rates as one of the most important themes that will drive investment markets over the next 12 to 18 months.
Low interest rates drives speculative activity because it becomes cheap to borrow money to chase returns, while plugging a low discount rate into valuation models gives a higher answer when trying to figure out the intrinsic value of a share.
“Given the fairly extreme point that we’re starting from now, it follows that when rates start to rise the effect on valuations will likely be equally as pronounced, albeit in the opposite direction,” warn Biddlecombe.
In addition, lower interest rates mostly increase companies’ profits because their interest costs fall, while it also put more money in people’s pockets.
Several analysts and investment managers have already referred to the curious anomaly of an increase in household savings over the last year, while one would have expected that people would be a lot worse off following the lockdown. They concluded that forced savings – because a lot of people carried on working but did not spend money due to lockdown or being uncertain – would be an important factor to watch going forward.
Biddlecombe referred to an article in the Wall Street Journal that related the experience of the average American, who enjoyed an increase in disposable income as fiscal stimulus and lower interest rates put more money in their pockets. And there is more stimulus to come.
He dug into US banking data which shows that Americans have more money in their bank accounts than a year ago and their credit scores have improved significantly.
His conclusion is that Americans’ savings are $1 trillion higher than usual.
The result of this “consumer firepower”, says Biddlecombe, is that consumer spending will most likely rebound in the next 12 to 18 months as vaccines are rolled out and the coronavirus pandemic subsides.
He highlights two factors driving the market in the short term.
Impact of higher consumer spending
The first is that higher consumer spending would increase inflation, which would lead to a normalisation of interest rates. Those extremely high shares prices could face risks, while others may benefit from renewed revenue growth. Biddlecombe says investors might be wise to avoid index-tracking exchange-traded funds (ETFs) as markets have run hard in the short term, while shares in the hospitality sector are bound to recover from their low levels when economies reopen and people start to enjoy themselves again.
Look beyond the Faangs to the ‘Beach’ stocks
A second factor is that the Faang stocks (Facebook, Amazon, Apple, Netflix and Google/Alphabet) are to be replaced by ‘Beach’ stocks (bookings, entertainment, airlines, cruise/casino and hotels) – a catchy acronym to show that a new trend is starting.
“This is where the opportunity lies,” says Biddlecombe.
He proposes avoiding shares trading on very high price-earnings ratios (above 30 times) and focusing on neglected consumer shares.
Not that big tech companies should be avoided …
A third important factor to influence markets this year is the push in the US to rein in the huge technology companies, says Biddlecombe.
He maintains that legislation has been very favourable for these fast-growing companies since at least 2000, and that tech’s “golden age of no regulation” has concentrated investment funds largely into the big five tech companies.
“Anti-trust legislation can lead to the break-up of these companies and unlock value for investors.”
Biddlecombe mentions a few examples, such as Amazon subsidiary Amazon Web Services or Google Cloud (part of Alphabet) that could be rated higher in the market if they were to list separately.
We will see how these expectations play out in SA too.