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.

Hi everyone,

When I wrote to you in September tech stocks had been performing exceptionally well. I said this was due partly to the fact that, since the onset of the pandemic, we had done a lot more staying at home and doing things like watching Netflix rather than flying around the world. Since then, however, humanity has been given a light at the end of the Covid tunnel in the form of vaccines. One result has been that the stock prices of ‘Covid losers’ such as airlines have performed extremely well while the big tech stocks have mostly lost money. Despite our dark winter, the market is looking at 2021 as a year of normalisation, which, assuming we get a relatively smooth and successful vaccine rollout, makes sense to me.

As ever, the question is what happens next?

My base case is that things in the real world continue to improve and we will spend far more money in 2021 in ways we did not in 2020 (a flight to see my family in Canada is a top priority for me, for example). I suspect that by the summer it will be extremely obvious that spending in the developed world is booming. The market has priced in most, but probably not all, of this rebound.

But this more positive environment will likely lead to central banks talking about removing some of the extraordinary support they put in place in 2020. So while we are, hopefully, enjoying seeing more of our families and friends, financial assets like stocks and bonds will likely find that one huge tailwind that they have enjoyed is diminishing. Perversely, what is good for humanity might not be so good for stocks – especially the high flying big tech stocks that benefited the most from both Covid and the support of central banks.

To get more technical for a moment, the extent to which inflation returns will likely make a big impact on central banks’ – and especially the Fed’s – withdrawal of support. There will be inflation in the first half of this year – that is almost guaranteed because of the base effects caused by the massive deflation of March and April last year. The question is whether inflation is sustained at that higher level. We will not know the answer to that until late 2021 or even 2022 but the market will likely begin to price in the answer before then (and the higher and more sustainable inflation looks, the more likely the Fed will withdraw support).

There are certainly risks to my good-for-humanity, reflationary base case. One of which is the emergence of a strain of the virus that is resistant to the vaccines or some other development that means the economic devastation wrought by the virus will be with us longer than I expect. In this scenario, the ‘Covid winners’ would likely be the winners again – at least on a relative basis.

It’s also possible – and arguably more likely – that the world will experience some sort of inflationary shock, like a big spike in commodity prices. As I’ve written before, the effect of this would probably be bad for most assets but I think our portfolios would perform better than most if it did occur.

Nevertheless, I expect we continue with a ‘healthy reflation’ in 2021 albeit probably not in the dramatic, one-way fashion that we have since the first of the vaccine announcements was made in early November. In theory, this should be good for the stock market as a whole, but I am wary of the market’s response to reduced central bank support and expect some choppiness.

So what are we doing for clients in this more uncertain investing world?

  • We remain significantly invested in global equities that are, in our view, more fairly valued than the big tech stocks that dominate the global stock market. Within equities, we have gradually and moderately increased our exposure to FTSE 100 and FTSE 250 – at the expense of global equities – for UK clients. We remain overweight emerging markets, especially in Asia. This strategy should continue to do well if the ‘reflation’ trade continues and I think will prove more robust than ‘the market’ if we experience the higher interest rates that would result from the withdrawal of central bank support.
  • Outside of equities we are quite cautious. Many of our peers are invested in ‘fixed income’ (e.g. bonds) that are far riskier than the fixed income of previous eras. I just don’t think the risk is worth the paltry rewards on offer; and those paltry rewards will look even worse if interest rates go up further. Instead, our non-equity exposure consists of market-neutral equity funds, low-risk bonds and USD and GBP cash.
  • In sum, it’s somewhat of a barbell approach. If we get a runaway, boom year then our clients should make good money with their equities. If we get a problematic year, then their portfolios should be better protected than most because of the safety of their non-equity components (this would be true to the extent that the client owns non-equity exposure, which is a question for the financial planning process).

As ever, I hope all of this is helpful in some way. Please feel free to get in touch if you would like to discuss it further.

With my best wishes,
Scott

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Scott Tindle, CFA is the Founder & Director of Wealth Management at Tindle Wealth Management

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