Moving Forward with What Matters
In a world of uncertainty, it feels reassuring to have a few reliable forces to fall back on. One such driving force of growth is the willingness of the US consumer to spend. Especially, but not exclusively, when they have money. And now they do. The super charged recovery and its super easy monetary policy have led to a surge in both US consumer income and wealth across housing and equities. US retail sales are therefore up 23% compared to pre-Covid. US equity markets have returned more than 75% over the last 3 years (see Figure 3) and as shown in Figure 1, below, US housing and the consumer in general are supported by mortgage rates close to a 10-year low. It is therefore difficult to see the US consumer slowing down sharply, even if the current or the next variant of corona virus should eventually lead to a lockdown. Consumers have by now got used to the lifestyle of “pandemic independent on-line spending”. With growth driven by the demand side of an economy, this is important, particularly now that European and Asian politicians have again started tinkering with the idea of closing borders and locking down various groups of citizens. As reflected in the recent relative and absolute pricing of Emerging Market and European equities, these political decisions are not good for local equity markets.
It is therefore of primary importance that the two main drivers of the global recovery, the Chinese and the US economies, keep humming. For all their differences, we think Biden and Xi understand that it is also in their own interest and will now be working towards this goal. With an ongoing pandemic and a record rally in risky assets, there are more than a few reasons for markets to be nervous, and there is always the risk that this nervousness will lead to a self-reinforcing market panic. Such a panic has the potential to take the US and the global economy down with it. One would therefore think that politicians and policy makers would communicate clearly and
Figure 1. US Mortgage rates remain close to a ten-year low and will continue to support consumption
carefully. Powell still found it appropriate to state that corona virus leads to future uncertainty with regards to both the upside and the downside of inflation. This seems more like an excuse for not meeting his target than the intention to clarify. This was done at a market rattling session in the US Congress on the 30th of November where he stated that inflation is not transitory and that he would be in favour of the FOMC discussing wrapping up the asset purchase program a few months earlier, when they next meet on 14th - 15th December. This kind of open-ended statement from the Fed Chair is too laissez-faire for our liking. The Fed’s credibility would have been better served by describing the whole situation as we think it will play out, that is to say, if equities dive and Covid leads to global panic, the Fed will ease. If there is no market panic, there will be further and clear information on the changes in tapering after the next FOMC meeting. It would then leave it to the FOMC, as the policy setting unit, to decide whether they think inflation is or is not transitory. Maybe the result will be the same, and maybe the Fed will hike twice next year, as it is currently priced in the market. Only time will tell.
US retail sales are among the most important drivers of the global economy and market and therefore feed directly into our algorithms. This part of the algorithm is still as strong as it can be. Together with the continued strength of the profit recovery, this is the primary reasons why our algorithms are still holding up and why we remain fully invested in equities. These strong profits also serve as an explanation why US equities trade at a lower P/E than at the beginning of the year. Along with a still very accommodative monetary policy, it is the reason why we do not expect defaults on high yield bonds to move up significantly from current levels. We are thus maintaining our long-held equity and high yield positions with their US biases. For those who have not already established a position in global growth and technology stocks, a good option is to buy into this via sustainable investing. One way of doing this is through a Sustainable Equity portfolio such as the one we introduced a year ago. As we show at the end of the publication, performance has been strong, and it is certainly not the worst hedge against a resurgence of the pandemic:
We maintain a 100% equity allocation (40% overweight) in our Systematic Equity Allocation strategy and the associated ACCI SA fund. As of the end of November the strategy was up 19% YoY and 24% YtD and the fund was up 16% YoY and 21% YtD respectively.
Across our global fixed income opportunities portfolios, we maintain our short duration high credit risk positioning. Despite a small setback, these strategies are up 1% year to date and 2% year on year.
In our multi-asset mandates and funds, we retain the full allocation to equities and the enhanced 30% allocation to high yield bonds. These portfolios are now up between 12% and 14% YtD and closer to 16% YoY, with the corresponding ACCI Diversified fund up 11% YoY and 14% YtD.
What exposure fits the risk picture?
There is comfort for some in buying on a dip or a relative underperformance and therefore emerging market or EMU equities might be considered. This is not our approach. There is nothing in the current cyclical situation or in the political development or environment in Europe which is encouraging us to buy either EMU or UK equities despite their underperformance relative to global and US peers. As shown in Figure 3, below, the EMU index has again regained its high correlation to Emerging Markets and Chinese equities. This is no surprise given the role Asia and China play in the demand for EMU companies, from LVMH, Hermes and Kirin, to Daimler and BMW. Although it is not surprising, it is not a very welcome correlation.
The lack of focus on the important topics in Europe is well illustrated by the fact that France and the UK, both claiming global importance, spend a considerable part of their government’s time quarrelling over fishing rights. This is a topic which has been with us for the better part of this writer’s life and, independently of its importance for some people, it seems to reflect the increase in populism. Not exactly something that is needed in the face of increased Covid cases and not something that persuades us to buy more of the underperforming EMU or UK equities. Instead, we primarily hold on to our US equity positions. The key reason continues to be that the US is more of a growth and transition friendly country than anything we are used to in Europe. It is also friendlier towards capitalism than either Europe or Asia. We do not know the precise reasons for Biden’s latest comments on Covid, but we note that on this point he is more economically friendly and market supportive. He has made it clear that for the time being there will be no US lockdown to counter the new Covid variant. One possible
Figure 2: Global equity markets return over recent 3-years
reason is that another lockdown in the US would play into the hands of the Republicans and Trump, which is obviously not in the interest of the Biden administration ahead of next year’s mid-term elections. Whatever the reason for Biden's politics and whatever the view one has on the virus, vaccinations and quarantines, we think that these recurring virus mutations will support the case for a technological upgrade of the global economy in two main ways:
On one hand, the direct effect will be that more and more businesses will see increased incentives to improve their ability to operate and sell via digital networks.
On the other hand, one thing everyone can agree on from Tokyo, through Beijing, to Berlin, Paris, London and Washington, it is easier to push through the fiscal policy response within a “Build Back Better” political framework. Together with “Green Transition terminologies”, these things are likely to be the core of a fiscal response if the next round of the pandemic really strikes.
A sustainable investment portfolio and its outperformance in the last year
The focus on and funding of the green transition should be supportive for what we in broad terms call sustainable investments (including both ESG and SRI). And this has apparently been the case. Towards the end of 2020, we introduced the upgraded version of our investment process for Sustainable Investments and the associated Sustainability Matrix. In the period since then, there has been some controversy concerning this type of investments. As more companies have made claims to be offering sustainable solutions, authorities have started looking at the supposed strategies behind them. At least one major fund management firm has had an outright scandal, a crisis of confidence, and an associated severe correction in its equity price. At the same time, a number of regulators have guided and gestured on the topic and both governments and the ECB have made claims to be providing funding to such investments. This has now reached a point where building what used to be considered “run of the mill” infrastructure, such as gas fired power plants and railway and bus stations, are sometimes categorized as green investments if they are called “transport hubs” or “sustainable energy infrastructure”. While these types of investments are needed, it would suit public institutions to set the bar higher and the EU commission to secure the forthcoming rules and regulations for sustainable investment. Still, this should not detract from the fact that ESG and SRI investment have outperformed recently and are still very much needed:
A transition to a less polluting version of the global economy is an imperative.
There are strong moral arguments for continuing the work towards a fairer and a more functional version of the global economy.
If you believe in education and hard work, there is a string human and economic potential broadening the opportunities for a larger set of people and to level up the playing field on which business in its various forms is conducted.
In the process we need as increasing transparency, accountability and governance
Direct impact investments remain an interesting area in pursuit of these goals, but as we argued in Allocating for Impact, in 2014, these investments are potentially best suited for Private Markets. Liquid markets are perfectly suited both for ESG and SRI investing This can be both in the form of Exclusion (not doing as much damage as before) and in terms of ESG leadership across industries and sectors. As seen in Figure 3, these investments have also outperformed the last year and before.
Figure 3. Edge Sustainable:
e are happy to go into more detail of how much of this is technology driven, how much is based on regional allocation, and how much is based on higher risk and higher beta with anyone interested. For this purpose, there are a few noteworthy facts worth spelling out:
There are some simulations in the date, but now backfitting of the last years returns as the Sustainable Investing portfolio we show as the black line in Figure 3 has the same structure as the one we showed in this publication in December 2020.
The portfolio has a CO2 emission level per USD of turnover of approximately half of that seen in MSCI World.
The majority of underlying companies are rated as leaders in their industry and sector (AA or AAA).
This 100% equity portfolio (the black line) is up 28% year on year, as of the 30th of November, 9% more than the 19% year on year gain of MSCI World (iShares ETF) shown as the grey line in Figure 3.
As seen in the top right-hand corner of Figure 3, the Edge Sustainable 100% “Benchmark“ portfolio we have created, the volatility is close to 15% since 2015. The reason is that all markets are correlated and that both MSCI World and our Sustainable Investment portfolio consist mainly of US growth companies with a large focus on the application of new technology. It is therefore likely that if and when the current bull market turns sour, these indices will also be correlated to the downside and then our investment process with its systematic risk management via asset allocation changes will be useful.
Figure 4. Company and industry overlap across Technology, ESG and SRI investing across index ETF`s
Best regards,
Mads N. S. Pedersen, Managing Partner and CIO