“October: This is just one of the peculiarly dangerous months to speculate in stocks & shares. The others are July, January, September, April, November, May, March, June, December, August and February.” – Mark Twain
Doom sells. Whether stock markets and economies are rosy or wobbly, making predictions of impending disaster is something of a competitive sport. Perma-bears and doom merchants are famous for predicting 20 of the last three recessions while financial pundits devote time and energy to warnings about things that could go wrong.
It is an old stock market adage that markets climb a wall of worry and right now the reasons to worry are plentiful. However successful long-term investing requires the discipline to ignore short term market noise and to focus on fundamentals. At Clarion, we always take a balanced view and here we look at the negatives currently stalking markets whilst also highlighting the positives.
The silent thief known as inflation is defying sober expectations and central banks know they cannot seek to puncture it without torpedoing the stability they have worked so hard to foster since the start of the coronavirus pandemic. Even worse, there is a whiff of stagflation in the air. The word that dominated the 1970s is recurring ever more in economic and financial dialogues. Google searches for “stagflation” are running at about 10 times their level from 2008, when the toxic combination of low growth and rising prices last appeared as a risk to living standards and prosperity.
The price of just about everything – equities, risky corporate bonds, property, cryptocurrencies, used cars, you name it – is sky high. Supply chains are in a mess. In a matter of just a few weeks, Britain and the world have moved from the roaring twenties to the winter of discontent.
In March 2020 as the coronavirus pandemic spread across the globe, the International Monetary Fund described the downturn as a crisis like no other and declared it the biggest hit to the global economy since the Great Depression.
The impact of that on shipping, global power generation, commodities and manufacturing was enormous as large parts of international trade infrastructure were mothballed. The world economy bounced as vaccines gave us hope and Britain’s economy expanded by an unexpectedly strong 5.5% in the second quarter. However, what we have learned in the last few weeks is that bringing the world back to where it was in 2019 is not an overnight job.
After the prolonged economic shock, the “coiled spring” of recovery has jammed and supply bottlenecks have become the wrong kind of disruption with companies as diverse as Wetherspoons to online electrical group AO posting disappointing financial results.
Over in USA, despite a short-term solution to the debt ceiling crisis, the Government will run out of funding in December, unless Republicans and Democrats can reach agreement on a law which allows the US Treasury to produce new dollars. Without a resolution the Treasury will run out of money by the end of the year on current projections. There has even been a suggestion that the US mint could print a one trillion-dollar note to allow financing for public services to continue without disruption.
And how about a poorly anticipated global energy crisis, just for good measure? Oil prices are at a three-year high and rising due to surging demand and tight supplies. Gas prices are at all-time highs. Rising input costs and weaker growth are likely to weigh heavily on corporate profit growth.
Any or all these things could spoil the fun in risky stock markets that are priced for perfection and highly sensitive to a switch in direction from monetary policy. The Bears are convinced that this will be the case… and soon.
But several of these factors have been known for some time and have failed to leave a lasting mark on the long-term upward trajectory in global stock markets. The quarter just ended has been a little more challenging with global stocks ending broadly flat but still up some 60% since March last year.
In a trading nation as open as the UK, global factors will always have a big influence. Nevertheless, there should be optimism that an economy that is as flexible, innovative and creative as that of Britain will recover lost ground.
The Optimists also point to business disruption and digitalisation as reasons to be cheerful. The digitalisation of everything outweighs any debate about inflation, stagflation and the next steps from central banks. Consumer technology, retail, media and other industries have already reshaped our lives and markets. Sectors still ripe for a revamp include finance and banking, which is moving from a reliance on branches to mobile phones. The pandemic has accelerated that process and the likely continued rebound in the economy next year will provide a further boost.
The return of risk appetite to the boardroom, boosted by vaccine rollouts and strong growth over the summer, has led to a surge in global mergers and acquisitions activity. Around $4trillion in deals have been announced since the start of the year, putting 2021 on track to break the previous record set shortly before the financial crisis. The weight of money competing for opportunities is driving up prices. The FT recently reported that private equity firms are offering the highest premiums for listed companies in more than 20 years, an average of 45% above the share price for European companies. Some recent bids have been even greater. US private equity firm Clayton, Dubilier & Rice offered a 61% premium for the UK supermarket chain Wm Morrison.
M&A is also spurred by the disruption of existing industries and processes, and the pandemic has been a disruptor of historic proportions. Businesses are positioning for lasting change. M&A offers a quick route to increased capacity, different business models and new, often digital, capabilities. The increase in M&A has been broad-based, but with a focus on acquisitions designed to accelerate technological change. Earlier this year Microsoft announced the acquisition of Nuance Communications Inc, an artificial intelligence and speech recognition software company focused on the healthcare industry, for $19.7bn and recently Uber purchased US food delivery service Postmates for $2.65bn.
The long-term upward trend in global equities has not been dented by two world wars, oil crises, disruptive technology change, countless financial meltdowns, terrorism, or a global pandemic. Yes, we will always have volatility, market crashes and occasionally the doomsters will have their day but betting against stocks and shares over the longer term makes little sense, more so when interest rates and bond yields are so low.
We continue to believe that the optimal defence against inflation, stagflation, and severe financial repression is a well-diversified, reasonably priced portfolio of quality global stocks & shares, which offer strong prospects for growth. Including companies with pricing power, and those which benefit from rising rates and inflation further lowers the risk. Short-dated inflation-linked bonds are still under-pricing inflation risk and are a more attractive option at this point than alternative solutions.
This has been the Clarion theme for the past few years and represents our core asset allocation, weathering numerous market environments well albeit with bumps along the way. We remain committed to this strategy.
October can often be a spooky month for stock markets because some of the worst crashes in history; 1929, 1987 and 2008, have taken place in October. It is one of the most volatile months of the year and that is certainly the case this year.
Investors have been preoccupied with a range of issues from rising inflation and persistent supply chain snarls to the debt crisis at China’s Evergrande Property Group and a looming US debt ceiling deadline that could thrust the US into its first ever loan default.
The recent jump in bond yields has also spooked investors and deflated the stock market but baring a sudden spike in rates, a gradual increase in bond yields will ultimately be positive for investors. One of the reasons for an increase in bond yields is the expectation of an expanding economy and that is a net positive for the market.
But volatility whilst uncomfortable is different to risk and brings opportunity for the longer-term investor to buy the shares of good companies at lower prices. This is exactly what our select band of fund managers are doing. Good fund managers embrace volatility and use down days to cherry pick the shares that are on their wish list, whereas private investors often run for the hills, creating bouts of uncomfortable swings in value.
Examples of the opportunities which have been thrown up by the current malaise in markets are many but, for instance, one of our fund managers has recently opened a position in a company called Atlassian which supplies tools such as Excel and Word to software engineers and developers, an industry that is growing at 20% per annum worldwide. One fund manager has added to his holdings in Veeva, an American cloud computing company focused on pharmaceutical and life sciences industry applications.
Yet another has increased the stake in Microsoft on current weakness. Microsoft has recently announced increased subscription costs for Office 365 and Teams of circa 15% which will feed straight through to the bottom line and free cash flow. Microsoft can boast a gross profit margin of close to 90% so is not subject to the same input cost pressures experienced by less profitable companies. Pushing up prices to match, even ahead of, inflation will be beneficial to the bottom line even if there is a hiccup in turnover which, as more people work from home, is unlikely.
There could well be more downside ahead but not enough to completely derail the bulls. The world is still awash with cash looking for a better home than the negative returns on bank deposits and bonds; this will be the umbrella that keeps stock markets propped up for a while and take it to new highs, once the cool wind of extreme negativity blows over.
Headlines about COVID-19 may have temporarily diminished but the pandemic is far from over. Global case rates and deaths have trended down since late August, but numbers remain at high levels.
In the UK, COVID-19 mortality has been averaging over 130 per day for the last four weeks. Case rates are elevated, partly because of a sharp increase in infections among lightly vaccinated but highly tested school-aged children. Cases in England among 10-14-year-olds have risen over four-fold since early August and are higher than for any age group at any point in the pandemic. England’s chief medical officer, Professor Chris Whitty, estimates that perhaps half of children have had COVID and said that it was a “near certainty” that unvaccinated children will eventually catch it.
If pressures on the NHS mount, the UK will move to the government’s “Plan B”, deploying a familiar set of tools including mask mandates, vaccine passports and advice to work from home. Case rates can rise very quickly, and to pre-empt the sort of surges in cases and deaths seen in April last year and January this year, the government would need to move rapidly. As the SAGE advisory group said recently, “early low-cost interventions may reduce the need for more disruptive measures and avoid an unacceptable level of hospitalisations”.
Set against these risks is a wall of vaccinations and of immunity acquired through infection. The UK has fully vaccinated around two-thirds of its population and an even higher proportion of older, at-risk age groups.
Vaccine immunity against hospitalisation or death does not appear to wane as quickly as its falling effectiveness against infection, and the administration of booster vaccinations will put further obstacles in the virus’ path. The rapid roll-out of boosters in Israel, where more than one third of the population have had the extra shot since August, has, together with a tightening of restrictions, led to a sharp decline in case rates.
Standing back from the current data, what is clear is that the world is having to live with COVID. Early hopes that vaccines, new treatments and restrictions would end the pandemic have been dashed but the balance of informed opinion seems to be that a mix of restrictions, booster shots and changes in behaviour should enable the UK to avoid another full-blown lockdown. Modelling by the government’s specialist advisory group, SPI-M, does not anticipate a significant resurgence in cases, hospitalisations or deaths. Professor Neil Ferguson, whose modelling of the pandemic was influential in the UK entering lockdown last year, said recently that he thought the UK would probably get by without locking down again.
COVID has proved an adaptable and resilient foe and while we may be losing interest in COVID, sadly it has most certainly not lost interest in us and the titanic struggle to suppress the virus looks set to continue for some time yet. No one is safe until we are all safe.
“Why does a grande Starbucks coffee cost three times more than a litre of fuel?”
Think about food. For most of the history of the human race, people died from starvation and a shortage of food, and in certain countries still do. This generation however is the first that will see more deaths from eating too much, as diabetes and obesity become prevalent.
Equally with respect to energy, why does a grande Starbucks coffee cost three times more than a litre of fuel? No wonder we have climate change!
Capital has become so cheap, even free, that the amount corporates and consumers can borrow is far in excess of historical levels. What happens if energy, food and capital become scarcer? Well in the first instance it will be inflationary, something we are maybe seeing now, as the same amount of demand fights over the decreasing level of supply. Thereafter it will become demand destructive as consumers of energy, food and capital have to adjust their behaviours which in some instances might be no bad thing. As the saying goes, the cure for high oil prices is high oil prices.
There is a credible argument that key commodities should be priced somewhat higher, in part so the world adjusts to consume less of them, which in turn should see prices fall again. This, combined with productivity improvements, suggests that inflation will not be a dominant driver of investment returns in the coming years.
At Clarion we continue to take all necessary precautions to ensure that our office is Covid safe and secure, for both staff and clients alike. We look forward to welcoming you to the familiarity of face-to-face meetings in Overbank in the weeks and months ahead although if preferred we are happy to have client meetings via Zoom and/or Microsoft Teams.
We thank you for your continued support and we look forward to updating you regularly over coming months. As always please do get in touch if you have any questions.
Keith W Thompson
Clarion Group Chairman
Creating better lives now and in the future for our clients, their families and those who are important to them.
Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.
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