JULY NEWSLETTER



31/07/2020







CURRENT SCENARIO


Since our last newsletter, global stocks are up 4.2%, Nasdaq up 6.1% and Shanghai index up 11.7%. The economic data, especially on consumption continues to do better than expected along with decent recovery in global trade. Not surprisingly, certain economies are showing better resilience in dealing with the pandemic and the economic impact.


China grew at 3.2% in the second quarter after a 6.8% slump the previous quarter (hence avoiding a technical recession which is signified as 2 consecutive periods of negative growth). US retail sales grew by 8% month on month, ex-gas sales in America also crossed its peak in Jan 2020. South Korea, Japan & Australia all fell into recession at the back of poor export numbers.


POSITIVE CASE FOR EQUITIES?


At the back of all the negativity on the economic front along with a gloomy sentiment, equities continue to show strong recovery since their lows in March. Is pricing the best case scenario the right way for a long term investor? Well, we have been driving the point in our regular communications to our clients that this rally is supported by a plethora of reasons other than fundamentals. That includes the central bank’s liquidity through monetary policies, government expenditure through fiscal policies, strong inflows from retail investors, technological transformation leading to significantly higher bottom lines for tech companies etc.


So is there a likelihood of the same continuing going forward and supporting the extraordinarily high valuations? In our opinion, QE and debt creation should continue strongly till 2021. Despite the rise in equities, global investor portfolios have significantly higher levels of cash compared to pre covid levels which should provide support for equities. US saving rate is at 23% now compared to an average 8% in 2019 leaving around $4 trillion available to be spent on demand. For UK & France, the savings rate is up 100% and 40% respectively from pre covid levels.


TINA ECONOMY- THERE IS NO ALTERNATIVE


If a bullish case has to be made for equities, the best argument would be TINA- there is no alternative available in the global financial market which is starved for yield with low bond yields. Infact, cash and high grade bonds will generate negative real returns for the near future. Our June Newsletter talks about the mandates for institutional investors such as pension funds & sovereign wealth funds- who would find it impossible to achieve set return targets with the current fixed income yields. The falling rates of both mortality and virus transmissions along with the positive developments over vaccines across the world has also prolonged the rally for now.


So does it mean Fin 1 Wealth is bullish on equities as an asset class? Well, we definitely would not be avoiding equities and increasing cash positions (current position stands at roughly 10% cash). The recovery has enabled us to rebalance portfolios with other asset classes and we will stick to the original asset allocation along with some changes on the thematic areas mentioned in the recommendations below.


THE TECH CONUNDRUM


The US tech giants continue to outperform global markets by a huge margin. Year to date, NASDAQ, which is dominated by technology companies is up around 14%.For 2020, Amazon is up a solid 57%, Microsoft & Apple up around 25%, along with 10%+ returns in Facebook & Google, whereas the broader S&P roughly down 1%. Investors are looking at the strong balance sheets and longevity of the tech companies’ business models along with their ability to gain from the incremental technological demand due to Covid.


Nasdaq’s asset under management has surged 34% from last year where investors are looking at incremental exposure to technology and pharmaceuticals. Tech companies have also benefited from robust retail investor participation. The fundamentals of the companies haven’t disappointed- with Earnings per share beating analysts’ expectations for the 2nd quarter.


Bubble talks?


Out-performance of tech companies by this magnitude is bound to start the bubble comparisons again. There is hardly any doubt that existing valuations are unsustainable. However, it is important to note that a direct comparison with the 2000 tech bubble might not be adequate. In the current tech bull run from April 2015-now, $1 in Nasdaq 100 grew to $ 2.4 i.e. 18.4% compounded return. In the dotcom bubble, $1 turned to around $12 i.e. a 60% compounded return! Not to mention that the underlying companies have stronger balance sheets, much bigger revenues and profits and the ability to attract capital due to longevity of their businesses.


Tesla short shorts!


The favourite of the shorters disappointed them as Tesla grew more than 5 times in market cap over the last 1 year. Only a few would disagree that the company is vastly overvalued. But that’s the thing with betting against a company. You might be 100% right about a correction to happen but almost every time wrong about the timing of the correction. Tesla has created a brand value attached to its cars and Elon Musk, combined with its ability to finally deliver on its projections. My favourite thing to come out from the Tesla story is Elon Musk’s quip by launching its own shorts.


And it's not a Fin 1 Wealth’s newsletter without at least 1 mention of Warren Buffet. No wonder he was criticized sharply for his exit in the airlines stocks and the loss incurred by Berkshire Hathaway, it is interesting to note that such a loss is less than YTD gain on his Apple position. In-fact, BH has close to $ 50 billion in unrealized gains alone in Apple. That makes it around 46% of the total Berkshire Hathaway's portfolio just in Apple. They would describe technology as their 3rd business now after insurance and rail-roads.


OUTLOOK


We believe that both economic and financial cycles would be cut short for the near future with frequent boom and bust cycles. Savers would have limited alternatives with record low interest rates and high valuations in pockets of equity. A heightened volatility over shorter periods of time is also likely. Gold should continue to be a valuable diversifier even at current levels. It is already at it's highest levels since 2012 and up 17% for the first half of the year. 10 year US treasury yields fell from 1.88% in January to 69 bps now. It would not be rational to expect wealth creation from fixed income in such an environment. OPEC’S oil output is expected to be its lowest in 30 years. A post COVID world would certainly be more digital, less global and heavily leveraged.


RECOMMENDATIONS


Diversification and asset allocation continue to be our focus. With cash and investment grade bonds to give negative real returns, selection within equities becomes further important. There is no easy way of saying that investors need to assume higher risks to match returns from previous years or simply downgrade return expectations to match existing risk profiles. It makes our role as advisor more crucial and we would recommend readers to have a professional manager to guide and assist.


The volatility in the markets should be used as a strategy to build long term portfolios using a disciplined approach to planning and rebalancing. Dollar cost averaging would continue to be as important as ever. We continue to prefer index participation in developed markets combining with thematic plays into value strategy and cyclicals. We like developed market high yields and USD denominated emerging sovereigns. Select Asian economies also provide a good opportunity, especially considering the increased pressure on USD to depreciate further from here.