Published: April 11, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold and Precious Metals
• Peter Schiff

Our Commentary

Now that Spring has sprung, there is a palpable sense of optimism in the air. The hope is that the dark days of winter will prove to have been the peak of the COVID-19 pandemic in the US and Europe, and that global growth will surprise on the upside this year, buoyed by the promising pace of vaccine rollouts and economies opening up.

Vaccine progress

The race to administer vaccines to curb spiraling infections and, in particular, hospital admissions was a feature of the quarter. Globally 15 million doses have been administered but most countries have barely started. Nonetheless, the US and the UK have seen infection rates coming down significantly.

Progress in the EU has been slower. The region is battling to roll out vaccine programs fast enough and infections are rising steeply again, particularly in France where hospitals are filled to capacity.

Irrespective of regional differences, it is clear that the global impact of the pandemic will continue to impact daily life for some time. Governments will attempt to reopen their economies depending on the infection rate’s improvement.

Will Bulls prevail over Bears?

After a turbulent February and March, the US stock market has staged a full recovery and continues to hit new highs. The S&P 500 index climbed past 4,000 for the first time in its history, while the FTSE 100, hindered by a large financial sector and lingering worries about Brexit, has recovered to within 10% of the level at which it began last year.

Cyclical stocks that were hardest hit by the pandemic last year, as well as emerging market assets, have been the primary beneficiaries of the reflation trade that has prevailed during the quarter. The cyclically adjusted price-earnings ratio is now the second highest it has ever been which could be evidence of a speculative bubble. It is, however, usually the pre-emptive tightening of monetary policy that bursts a bubble, we see no sign of that coming any time soon.

While equity investors’ sentiment is still bearish, their worry is nothing new. A chart of the US stock market recovery from the financial crisis in 2008 looks like one continuous worry-free bull market. Even the eurozone crisis of 2012 barely registers more than a blip. In reality, we know that throughout that decade things certainly didn’t feel so calm. Looking back, there was always a long list of dreads demanding the attention of financial pundits, investors, and global asset allocators. One of them is rising treasury yields.

A closer look into bond markets

In recent daily press, the stock and bond markets have been way ahead of the mood, especially bonds.

Throughout most of the recovery, sovereign yield curves were firmly positive, forecasting a rise in interest rates that never came. Instead, they fell further to nearly zero, providing fuel for the rising stock, bond and property markets.

In the US, UK and even in Germany, bond yields have risen to where they were in January 2020. The direction of travel has been similar across all developed markets. But that is where the similarity ends. The US 10-year Treasury now yields 1.7% whereas the UK 10-year Gilt yields less than half that. The German bond is still in negative territory, yielding -0.3%. This is a big difference.

Combined with the continued strength of the US dollar, some analysts believe treasuries could yet again prove to be a tempting target for asset allocators while only a minority are anticipating the rise in yields to directly precipitate a bear market in equities.

Central Banks will keep rates low…for now

Inflows from the rest of the world would ultimately act to put upward pressure on the US dollar. This, in turn, would alleviate inflationary pressures in the US – which is what everyone seems to be worrying about.

Perhaps this explains why the US Federal Reserve appears to be so sanguine about its own inflation targets? The European Central Bank, perhaps fearing a sell-off in its own government bonds, has stepped up its bond-buying program to keep yields down. While the US can seemingly prosper with relatively higher borrowing costs, clearly the concern of the ECB is that the eurozone cannot.

In addition, because rising 10-year yields push up expectations of future rate rises, the UK could also have a problem with its sensitivity to rising base rates. This is because the payments for UK mortgage borrowers are linked to short rates in a way that those of US borrowers, linked to 25-year rates, are not. The Federal Reserve may be reluctant to raise base rates back up to 1.5% but for the Bank of England it is almost unthinkable.

Whatever directions that bond yields may go, our international funds are well-diversified to be resilient against the current market’s volatility and fears.

Precious metals

The prospect of inflation that so bugged investors actually came in the form of rising asset prices rather than in the cost of living. The gold price doubled in the years following the financial crisis and while there has been some profit taking since the US election, gold retains many attractions, from being a potential inflation hedge to a safe haven.

We retain exposure to the gold price as inflation, rather than Covid-19, appears once again to have been investors’ main concern since the start of the year.

Stock market outlook

Economically-sensitive stocks should continue to perform well, albeit they remain susceptible to bouts of volatility sparked by movements in bond yields. The $1.9tn US fiscal package, continued monetary policy support, rising vaccine supply and distribution, and significant amounts of corporate and consumer cash waiting to be deployed are tailwinds of equity values.

Earnings continue to beat consensus analyst estimates and conservative company guidance with earnings momentum greatest in energy, materials, financials and information technology.

Technology remains within the top five earnings momentum plays, even though mega-cap technology stocks were the most affected by the reflation trade and rise in bond yields during the first quarter. Economically-sensitive sectors, including cyclical stocks and reopening plays, could surprise further to the upside.

Moreover, after a decade of over-predicting inflation, central banks will require strong evidence of wage growth before reducing stimulus this time. This is supportive of positive stock performance in the future.

Portfolio Actions

Historically, April has been bullish for US stock markets. Despite the devastating impact of COVID-19 to the global economy, we have seen bullish sentiment remaining resilient in many stock markets. However, rising treasury yield remains a threat to Tech stocks that we cannot undermine.

We believe that our funds with exposure to US stock markets are currently well-diversified so that an unexpected performance of either the stock or bond markets may become a neutral factor to our portfolios’ performance.

Despite the Fed’s reassurance of keeping inflation under control, investors still fear that inflation may surprise to the upside in the short-term. Hence, we maintain our exposure in gold to capture both shot term and long term price appreciation of precious metals, which are affected by current easy monetary policy and expansionary fiscal policy of governments to jump start their COVID battered economy.

Lastly, we will continue to identify new trends and seeking exceptional investment opportunities to add to the growth potential of your portfolios.

Regards,

Euro Pacific Advisors Management Team

Published: February 05, 2021

Relevant Strategies

• International Balanced
• International Growth
• Natural Resources
• Gold & Precious Metals
• Peter Schiff

Our Commentary

Market Overview

The past year has brought not only huge market swings between risk-on and risk-off phases but also a staggering divergence of returns between regions and investment styles. In equities, much of this can be explained by sector performance.

The outlook for inflation is not yet strong enough for the sector rotation of November and December to have continued at the same rate in January but many investors are expecting the recent recovery of cyclical/value shares (consumer cyclicals, energy, industrials, and financials) to continue and the valuation gap to close.

Last year, it was a COVID-19-determined market, with sectors that benefited from the pandemic doing well and those that did not having a torrid year. The best performing sectors included tech shares, consumer defensives, basic materials, freight and logistics and homeware. The worst performers were oil and gas, financial services (banks), retail estate and airlines.

The graph below captures the state of play in the sectors towards the end of last year:

Sector divergence remains in focus

As vaccines are being distributed, we are optimistic to see how the sectors will perform this year.

In its 2021 Global Outlook, Blackrock has divided companies into three categories based on its bottom-up analysis:

1. Those in trouble that may fall further
2. Those that that are hurt but should recover
3. Those that are strong and could get stronger

The report sees airlines in the first bucket because business travelers account for a disproportionate share of profits and expects that companies will wish to continue benefiting from the cost savings made by holding events virtually.

Housing, materials, and autos fall into its middle bucket as the interest rate-sensitive parts of the US economy are already recovering strongly.

Meanwhile, the tech sector is in the third category as it leverages accelerated trends, offers scarce growth amid rock-bottom yields, and boasts high profit margins.

In the next paragraph, we will see how this sector divergence affects stock indices and their valuation.

Impact on indices

For the S&P500 index metrics such as price-to-sales and price-to-earnings are often quoted as evidence of overvaluation, but it is important to consider the impact of the high weighting now attributed to mega-cap tech stocks.

These stocks are generally more highly-rated, at least partly justified by high earnings and cash flow, so as the share prices have rallied it is only natural that the P/E and P/S ratios of the S&P 500 have risen.

The table below generated by Deutsch Bank shows sectoral PE ratios and demonstrates how shifts in sector performance can move index-level valuations. It is worth noting a theoretical scenario where the ratios applied to an index could rise without it being the case for any individual sector, purely due to sector performance divergence.

*based on earnings estimates for 2022

Understanding the misunderstanding about the current valuation of index, we will continue to adopt the wait-and see stance in the short and medium-term for our holdings of index ETFs. Until the sector performance begins to shift, which will affect the indices valuation, we will keep monitoring and wait for the right time to adjust their weightings in our International Growth and International Balanced Fund.

A new battleground between the US and China

This year, another key driver of financial markets is expected to be the relationship between the US and China. Although Joe Biden is likely to take a less confrontational approach than his predecessor, both countries are likely to seek self-sufficiency in critical industries.

We continue to ensure that strategies contain diversified exposure to both poles of growth. As China opens its capital markets to global investors, the spotlight may switch from the bilateral trade deficit to climate and human rights. As this trend is playing out slowly, we are also beginning to steadily reflect this shift in our exposure to China.

Global growth recovery?

The pandemic continues to wreak havoc in many parts of the world and expectations of short-term economic performance have weakened. Furthermore, vaccines now appear not quite the silver bullet hoped for when it comes to opening up the global economy while supply constrains rollouts and the effectiveness against virus mutations remains uncertain.

Many commentators, including JP Morgan, still expect strong, back-end-loaded global growth this year and tailwinds continuing to underpin stock markets in a yield-starved world. Nonetheless, we remain risk-conscious and prepared for all eventualities.

The rise of TaaS

In recent news, Amazon is reported to order 100,000 electric vans last year. While this is good news for the electric vehicle market, there is a much larger trend simmering behind the lime lights of Tesla (NASDAQ:TSLA) and NIO (NYSE:NIO) .

According to FN Media Group, the Transportation-as-a-Service (or “TaaS”) industry is expected to reach a market valuation of $8 trillion , of which includes ride sharing in personal and freight transport, food and drone delivery and distribution market.

In the next decade, we believe the sharing “gig” economy, along with autonomous vehicles, electric vehicles (EVs), ESG investing and connectivity will be the future as the world is moving away from buying and owning gasoline vehicles largely due to rapid urbanization, increasingly gridlocked roads, ever-rising CO2 levels and the fact that we are using our cars at a falling rate, according to FN Media Group’s report. More importantly, the TaaS industry is where all four macrotrends will intersect.

Portfolio Actions

Sector Rebalancing

We continue to adopt our cautious stance and refrained from rotating the sectors because there are still gaps between the sectors’ performance and their valuation.

Additionally, sector rotation may not happen until the next quarter when the US vaccination program begins to bear fruits and its positive effects on the economy begins to kick in with rising inflation. Only time will tell.

Transportation-as-a-Service

In terms of our call on TaaS’ emergence, we are slowly building our positions in relevant industries and sectors. For example, within our investment in USA ESG ETF and the US market ETFs, there are holdings in Uber and Dominoes, both of which are members of TaaS.

Environmental, Social, and Corporate Governance

To note, our ESG investments, both US and Global, also have exposure to other aspects of the supply chain of TaaS-related companies. Holdings include Albemarle (NYSE: ALB), FMC Corporation (NYSE:FMC) and Livent (NYSE:LTHM) of which belong to the EV supply chain and their use through the gig economy and connectivity. There is also exposure to Tesla rather than Rivian, which is still private.

In the last six to twelve months, we have slowly increased our ESG exposure because we feel these are areas that will take on greater significance for investors and companies alike with the integration of greener and socially responsible values a key driver in decision making and development.

Furthermore, as more candidates begin to meet our ESG criteria, they may be added to the equity portfolios over time. This steady process will also contribute to our exposure to TaaS in the long-term.

Regards

Euro Pacific Advisors Management Team