Our latest investment commentary from Avellemy Chairman, Graham Bentley

Graham Bentley

February 2021

Robust performance from the main markets.

The shortest month saw continued robust performance from the main markets, with the UK in particular benefitting from positive news that more than 30% of the population have had at least their first dose of COVID vaccine. It is now likely that the entire adult population will have had at least one dose by July. Given the indecision regarding earlier lockdowns, this is a remarkable achievement, and a target that our European neighbours may struggle to match.

The data supports the cautious easing of lockdown announced on the 22nd, providing a more positive near-term outlook for business that was unsurprisingly reflected in UK stock market performance, particularly of smaller companies. In the US on the other hand, the light at the end of the COVID tunnel is rather dimmer. The effectiveness of vaccine rollout varies between states, but currently around 15% of the population has received their first dose, with Joe Biden's target of 50% of the population vaccinated by July.

Concerns regarding the bursting of a technology stock 'bubble' in the US market.

The US market - more than half of the world's stock market value and thus the bellwether for global equity valuations - has deeper concerns coming into focus, including persistent concerns regarding the bursting of a technology stock 'bubble'. These fears refuse to subside, reflected in a near-25% fall for Tesla shares in February, yet merely returning the price to where it was in early January. US 'non-tech' equities in general continued to rise, hitting a new high on 8th February, but it is debatable whether there is indeed a developing bubble in stock prices occurring.

Equity prices are high, despite COVID fears, because bonds are very expensive.

These prices are supported by central banks buying back their own bonds, thus pumping money into their COVID weakened economies. As a result, bond prices rise, you pay more for the income they provide, so yields are low. If these so-called 'safer' investments like government bonds provide negligible or even negative returns in the form of interest (look at bank deposit rates), equities become more attractive relatively speaking.

Now the fear is that high government spending (e.g. President Biden's proposed $1.9trillion relief package) alongside rising commodity prices (as economic activity accelerates out of COVID), drives inflation higher. This would reduce the buying power of bonds' future income streams, forcing a compensatory rise in yields. Because interest payments are fixed, a bond's price has to fall in order to produce a higher yield, so bond investors suffer. However, if bond yields rise above the yield on shares, then the risk associated with equities becomes less tolerable. This would act as a brake on rising equity prices; if there is indeed a bubble, it would deflate somewhat if not pop.

Furthermore, the liabilities of borrowers fall as inflation rises - the 'value' of static repayments falls as prices (and incomes) rise. This helps governments that borrow just as much as individuals, as long as that rise in inflation does not get out of control, so a cynic might suggest central banks might engineer a 'healthy' dose of inflation, and rising bond yields might be a signal that is happening. The yield on the benchmark US Treasury bill has increased from 0.9% to 1.4% since the turn of the year as investors 'test' the resolve of the Federal Reserve to keep a lid on rising yields - although they have remained notably resolute thus far.

As for bubble territory…

Experience tells me stock market bubbles have been rather more obvious than what we are observing today.

Earlier in my career in the City in the 1980's, the focus of attention was on the rise of "Japan Incorporated". Capturing a quarter of the world's car market, and generating enormous trade surpluses, Japan Inc was an economic and manufacturing powerhouse, threatening to obliterate an outdated US industrial complex via a seriously strong lead in robotics, semi-conductors and manufacturing and bound by a cohesive society with a deep respect for corporate culture. This success was reflected in share price rises, but by association (and in particular) on property values, leading to a speculative bubble that saw the real estate prices in Tokyo rocket to £1m per square metre, making the emperors palace grounds worth more than the US state of California. There seemed to be no stopping its conquest of the West...

However, unbridled bank lending and rampant corporate 'trophy' spending led otherwise failing businesses share prices to rise, until the Tokyo Stock Exchange peaked in January 1990. A hike in interest rates to quell excesses saw the bubble burst, the market falling by almost 50% in 9 months. The bottom was reached nearly 20 years later, then down almost 70% in yen terms.

Despite this, Japan remains the world's second-largest stock market, yet with a 7% share, hence only a small part of the typical client's portfolio. My reason for mentioning it? An investment made in the index in February 1990 would have finally clawed its way back into profit last month, after a 30-year recovery.

Markets generally 'revert to the mean' at some point.

Excesses are curbed, and weaker performers recover. To paraphrase Kipling "If you can meet with triumph and disaster and treat those two impostors just the same...you'll be an investor!"

All of which reinforces the importance of investing within a diversified portfolio. An investor within the Avellemy Active Risk Grade 5 portfolio would have experienced returns of 9.41% over the 12 months to end February 2021, vs the Investment Association sector (IA Mixed Investment 20-60% Shares) at 6.51%.