Market Comment 11/11/2020
Risk Managed Funds Positioning Update - 11th November 2020
Two events of real significance (concerning US elections and vaccine development) have occurred during the last week. Hector Kilpatrick gives an update on the positioning of the Risk Managed Funds in light of this.
Concerning US politics, it looks as though Congress is likely to be split (ie. the House will be controlled by the Democrats and the Senate by the Republicans - although this will only be confirmed in January following the Georgia Senate run-off elections). This means that the ‘go to’ reflation policy response is likely to continue to be the politically expedient choice of printing money (quantitative easing) to purchase assets rather than the more controversial option of printing money to finance infrastructure investment. This would suggest that the growth style, which has been so dominant over value in recent years, will persist.
However, we expect two developments will challenge this view in the shorter term. Firstly, at some stage in the next few months (possibly in January following the elections in Georgia) a fiscal boost to the US economy is likely to be agreed and announced. It may not match the $1.8 trillion that the Republicans offered ahead of the election, but nonetheless it will still be meaningful.
Whilst the downgrading of economic growth forecasts due to renewed COVID-19 related lockdowns in the west will not trough for some time to come, this is now well known and with the news flow on a multitude of Ph III vaccine trials gathering pace, ‘animal spirits’ could be rekindled and the redeployment of cash that’s sitting on the sidelines is likely.
We know that inventories are low relative to sales in a lot of sectors (especially housing and autos) and that those who remain in a job have considerable excess savings. This means that the potential tailwind to growth in 2021 is significant, while the year-on-year comparisons for headline inflation will get easier as next year progresses. This argues for headline inflation and the real GDP growth run rate in Q3 2021 really being quite strong. We believe that this will be discounted earlier in terms of 10 year government bond yields and those assets which benefit from inflationary rather than deflationary environments.
While the likely lack of a ‘blue sweep’ (where the Democrats control the House of Representatives, the Senate and the Presidency) reduces the scale of the potential rotation in the coming months, we believe that the rotation that began in earnest yesterday (on the Pfizer vaccine news) can persist for some time.
Over the previous few months, we have been repositioning the Cornelian Risk Managed Funds for such an environment. Within UK equities, we have taken significant profits out of our holdings that have benefited from the COVID-19 related deflationary scare and redirected the proceeds into existing holdings which have suffered for the same reason. We have also added to our overall UK equity risk by allocating additional capital to those stocks which will benefit from an environment where economic growth is expected to improve. Likewise, we have added to our international equity holdings, outside the US, for similar reasons.
Given imminent Brexit clarity, the UK equity market could perform relatively strongly for a period as international asset allocators look to redeploy cash to a market which has lagged hugely, will benefit from a more positive inflationary outlook and has a stable, business friendly government. As a result, we have increased the level of Sterling hedging in the funds, in order to protect returns should Sterling strengthen from current levels.
It is important to note, however, that we do not believe that the rotation from growth to value styles will persist over the long term. This is not a structural change in momentum, although it may feel like that for a while. The reason for this is that the ever-increasing weight of debt, which is building at both the government and corporate levels, means that should interest rates rise materially, the economic recovery will be harmed and those assets which benefit from a more deflationary environment will come to the fore once again.
Head of Risk Managed Funds