20 April 2021
Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary below is not intended as a recommendation for you to personally buy or sell any of the investments mentioned nor to take any investment action whatsoever.
To understand where we are today it is useful to briefly recap from where we have come over the past 6 months. By September, stocks had already rebounded from their pandemic lows and, despite the global health and economic carnage, were sitting at all-time highs. That initial rise was led by stocks of companies that were expected to do relatively well out of the pandemic: the likes of Netflix, which we were all bingeing on at the time, and Zoom, which had become a staple of working life for many.
Stock markets are now even higher than they were in September but the gains over the past 6 months or so have been primarily driven by companies that had done poorly during pandemic: airlines, cruise lines and other travel related companies are easy-to-understand examples but of perhaps more importance was the strong performance of banks, miners and other companies which are, in general, tied to overall health of the economy rather than the growth of specific businesses like digital streaming or video calls.
We are now at a point where the future path is far more uncertain than it has been since the pandemic first hit. On the one hand, I think we will continue to experience an economic recovery. However, it is clear to me that the stock market - which is yet again near a record high level - is already reflecting much, if not all, of this optimism. Conditions under the surface of the market are now more complicated and therefore I suspect the delineation between ‘growth’ and ‘value’ will be less determinative of returns than it has been over the past year.
There is also a burgeoning problem which is that the better the economy does, the more likely it is that support for the economy will be pared back. I am talking specifically about the actions of the US Federal Reserve which, along with other central banks, has created a huge amount of new money. This has caused all assets that are not money - like stocks and houses - to go up in value. With the economy continuing to recover, the Fed’s justifications for creating so much money will wane - and I suspect so will its supportive actions. All else equal, this leaves the stock market vulnerable to a decline.
When and how the Fed begins to pare back its support may be the single biggest determinant of market returns over the next year. My sense at the moment is that the hints from the Fed will begin at some point between the summer and Christmas but I have low conviction on this call at the moment. Just as important as the timing will be the details of how the support is pared back - and that is particularly unclear right now. To say we are monitoring this closely would be an understatement.
Meanwhile, China is already paring back its support for its economy. While broader markets don’t seem to be too worried about this right now, it may prove to be a significantly under-appreciated risk. In fact, I think this is the biggest risk to the idea that the global economy will continue to strongly recover.
I find it difficult to be fundamentally positive about stock markets right now. The value of stocks relative to their profits are at historically extreme levels. However, there is also a significant upside risk that the Fed pares back its support much more slowly than expected. Coupled with President Biden’s plan to spend trillions of dollars this could continue to push up the price of stocks - as such actions have been doing for the past year. It is also, therefore, difficult to bet against this market. Nevertheless and to be clear: I expect the market will experience a significant decline later this year. So what are we doing?
The answer is that investors need to be highly cognisant of the risks that they are taking. Determining the appropriateness of investing in stocks is really an output of a proper financial planning process. It can - and usually is - a good idea to be invested in stocks so long as one’s time horizon is sufficiently long. Getting this decision-making process correct allows the investor to react positively when the market decline occurs.
Our investment approach remains somewhat of a barbell approach for clients: we are fully invested in stocks in line with our clients’ mandates (although we are getting close to a level where we are likely to reduce this somewhat). Our non-equity component is quite cautious especially, I suspect, relative to our peers; as an example, we own very few bonds especially of the higher risk variety. To get more specific: our portfolios will likely do well if the US dollar declines, which I think is eminently possible given President Biden’s spending plans and the Fed’s likely reaction (a prediction for those that want more granularity: expect to see Lael Brainard as the new Fed chair in early 2022 and she is anything but ‘hawkish’).
In short, I would characterise our approach as ‘responsible’. We are taking appropriate risk on behalf of clients but also aware that a significant selloff is likely later this year and therefore we want to be in a position to capitalise on that if and when it comes.
As ever, I hope the above is useful to you; please do not hesitate to get in touch if you would like to discuss it in more detail or would like to learn more about our financial planning and investment management services. Most importantly, I hope that from wherever you are reading this you are able over the coming months to recapture some of the humanity that we have lost over the past year. Here’s to a brightening spring and summer in every sense.
Scott Tindle, CFA is the Founder & Director of Wealth Management at Tindle Wealth Management
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