In keeping with the rest of 2020, Q4 brought further significant moves in equity markets. Given where we were at the end of Q1, it is remarkable that the S&P 500 reached new highs on New Year’s Eve. Technology stocks were the standout winner in 2020 as the Nasdaq rose 45% over the course of the year. The market rally in Q4 was driven by three important events in the quarter, all of which undoubtedly impacted the market and economic outlook.
US election: A Biden victory was the over-whelming favourite in betting markets and indeed the stock market had priced in a Democratic sweep of the White House and Senate running into the election. The Democrats also won control of the US Senate following the run-off elections in Georgia. The chamber will have a 50-50 partisan split, with Kamala Harris, incoming vice-president, having the tiebreaking vote.
A Democrat controlled Senate is likely to increase the chance of significant fiscal support via pandemic relief and long-term infrastructure spend. However, it would also increase the chances of tax rises (both corporate and personal), greater regulation and rising bond yields. With such marginal control of the Senate we suspect any major legislation will be difficult.
Vaccine data: The data from the various trials (Pfizer/BioNtech, Moderna, Oxford/AstraZeneca) has rightly been well rewarded by the market. Efficacy levels are in general higher than expected with safety issues minimal. These trial results have allowed the market to price the probability of a return to normality sooner; we can debate what the new normal looks like and indeed how quickly that reversion takes place, but this news suggests that a worst case is substantially less likely.
This news has had a substantial impact on companies which are more economically sensitive, or which have been negatively impacted by work from home/lockdown policies such as travel & leisure.
Brexit: Four and half years after the initial referendum the UK has finally agreed terms for the ongoing relationship post withdrawal from the EU. The deal was signed very recently and whilst question marks remain, the initial take suggests this is a reasonable outcome for both sides- it certainly removes the risk of ‘no deal’ and the economic instability that risked.
All three pieces of news were generally supportive for both the wider market and for the portfolio as the combination of events drove a significant internal market rotation. The portfolio performed well through this period as financials, industrials and select consumer discretionary stocks which have been relatively weak performers in 2020 have reflected a more optimistic outlook for 2021. However, we continue to see further upside for such sectors as valuations look attractive and we expect economic stimulus to continue to be a factor going forward.
As we highlighted last quarter one of our favourite measures to gauge the market is valuation spread. Spreads have continued to narrow, suggesting less extreme valuation differentials. Whilst still above long-term averages they are not quite as provocative as they were; this leads us to greater balance within the portfolio.
JP Morgan performed strongly as the bank reported excellent operating results, a resumption of capital return and the reduced risk of further draconian regulation under a Democratic sweep. Rolls Royce, Melrose and Amadeus performed well as the vaccine data allowed investors to begin to price in a resumption of flight travel, encouragingly, where air travel has re-opened there is clearly strong appetite from consumers.
Samsung, TSMC and Texas Instruments performed well reflecting a more positive outlook for memory and analog chips and general industrial production.
On the negative side, a number of companies which had performed well up to Q4 underperformed a strongly rising market; this is not wholly surprising as many were seen as ‘Covid winners’. Companies such as Home Depot, NetEase and Progressive fall into this category.
Bayer and CME also detracted from performance (more below).
This was a relatively quiet quarter in terms of portfolio activity; we introduced no new holdings to the portfolio and disposed of two.
Bayer issued a profit warning very early in the quarter principally due to challenges in their crop business. This was the latest in a series of disappointing updates from the company and caused us to re-evaluate our position; whilst undoubtedly ‘cheap’ we decided to exit. Data suggests that historically we have been too slow to exit losing positions, so we have taken the opportunity to move on. Our investment in Bayer has been poor, as with all mistakes we will learn the lessons to enhance our process.
We also disposed of CME in the quarter as we felt we had higher conviction holdings we wished to add to.
Whilst not full disposals we substantially reduced positions in three companies: ADP, Amadeus and JP Morgan. All three performed well in the quarter and our decision to trim reflected a desire to add to other holdings.
We added to 3i, Melrose and American Express; 3i was a new position in Q3 and we wanted to bolster the position size. Melrose and American Express we view as significant beneficiaries of re-opening and felt they should be larger positions within the portfolio. All three management teams have proven their ability during this downturn.
As we enter into February 2021, markets feel in a very different place to that of only a few months ago. Optimism has replaced fear as equity prices have rebounded. Certainly, it is understandable that markets have rallied with the resolution of Brexit, the US election and vaccine efficacy but it does leave us questioning, what next?
There has been a great deal of good news but much of this now feels ‘in the price’, certainly at an aggregate market level. With news of further virus spread any further lockdowns or negative issues surrounding vaccine roll out could undermine this bullish sentiment.
Whilst we commented on the portfolio changes above at a stock level, it is less revealing about the overall portfolio shape. Over the past couple of months, we have been trying to focus more on idiosyncratic risk. Throughout 2020 significant performance gaps were created between the perceived winners and losers of Covid. To some extent those remain but recent moves have reduced the extreme nature of those differentials.
A good example of this is the relative performance of two companies within the portfolio, Tencent and Melrose. Tencent is a dominant internet/gaming/social media behemoth and Melrose is principally a UK engineering business whose key business lines include automotive and aerospace. Through H1 2020, Tencent outperformed Melrose substantially as it was a relative winner. However, since the end of October, in sterling terms, Melrose is up over 48% whilst Tencent is down 9.5%- substantially narrowing the relative gap which had opened.
As these large performance differentials have reduced, we have been adding to positions which we see as idiosyncratic such as 3i and Alimentation Couche-Tard. 3i is a listed private equity business with excellent assets and the ability to deploy capital at high rates of return irrespective of the macro environment. Couche-Tard is a Canadian-listed operator of convenience stores globally; they have several internal revenue and margin enhancement projects underway along with a substantial acquisition pipeline- management have proven adept at navigating various macro environments over many years.
2020 was a difficult year for income-based strategies, many companies suspended or cut dividends as a precautionary measure, some were forced to by regulators (EU banks). In other cases, such as several large oil companies, Covid just accelerated the inevitable - pay-out ratios were unsustainably high. Indeed, over the course of 2020, the MSCI High Dividend Index returned -2.87% whilst the MSCI World delivered +10.82% (all returns in sterling).
We have often communicated the importance of dividend sustainability and growth and the need to avoid unsustainably high dividend yields and thus ‘value traps’.
We seek to invest in a portfolio of companies that offer an attractive income at the portfolio level. While dividend growth has been very difficult to predict over the last 12 months, we would expect that the portfolio (not withstanding further economic shocks) can deliver high single digit dividend growth in 2021.
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| Ordinary Share Price | 23.0 | 13.5 | -8.3 | 22.1 | -0.9 |
| Net Asset Value | 24.9 | 13.7 | -9.4 |
20.9 | 2.6 |
| MSCI World Index (£) Total Return | 29.0 | 12.4 | -2.5 | 23.4 | 12.9 |
Past performance is not a guide to future returns.
Ordinary share price performance figures have been calculated using daily closing prices with dividends reinvested. NAV performance figures have been calculated using daily NAV with dividends reinvested. The NAV used includes current period revenue and values debt at fair. The MSCI World Index (£) Total Return performance shown is total return (net of withholding tax). All performance figures are in sterling as at 31 December 2020 except where otherwise stated. Standardised past performance figures are updated on a quarterly basis. Source: Morningstar.
Kepler Trust Intelligence have put forward their views on the combination of Invesco Select Trust plc and Invesco Income Growth Trust plc, with a focus on the proposed joint management by Ciaran Mallon and James Goldstone.
Pandemic outbreaks have had profound and lasting effects on societies throughout history. They have decimated cultures, determined outcomes of wars, and wiped out entire populations. They have also been inflection points for society, clearing the way for innovations and advances in medicine, politics and the economy.
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