Investment outlook first quarter 2021

World economy

While a second Corona wave swept the globe, equity markets reached new all-time highs last quarter. Positive sentiment resulted from the election outcome in the US, the publication of better than anticipated results in COVID 19 vaccine trails and the broad felt hope that this might all lead to some kind of normalization in 2021. Markets were further supported by the EU’s agreement on a EUR 750 bln recovery fund and a second, USD 900 bln sized round of fiscal stimulus in the United States..

The outlook for the world economy has returned to positive. The latest consensus GDP growth estimates were minus 3,8% for 2020 but plus 5,2% for 2021 and plus 3,7% for 2022. With the implementation of the now available and pending vaccine programs, economic normalization is our current base scenario, albeit that some sectors may need much more time to recover. By implementing comprehensive stimulus programs, governments have drastically increased both spending and debt. Central banks are keeping interest rates low, even at higher inflation levels. In all, this offers a favorable outlook for equities.

Short term, the flow of capital will determine the price of equities. In 2020 we saw companies’ earnings and valuations being less relevant than should normally be expected, causing the returns of our portfolios to lag slightly behind their benchmarks. To clarify, we will discuss this flow of capital plus the recent developments in supply and demand of financial instruments below.

First the demand. This increases as monetary policy expands. The number of US dollars in circulation is now 25% higher than it was one year ago. The number of Euro’s in circulation increased by 10% during the same period. Together, the BoE, Fed, ECB and BoJ increased their balance sheets with USD 8000 bln last year. This inflow of capital is initially used by the central banks to buy bonds and thus finds its way into the financial system. A fund manager that sells bonds to the central bank under these quantitative easing programs can reinvest the proceeds in other bonds or in other financial instruments, such as equities.. Ultimately, more dollars and more Euros are chasing a limited number of financial products, causing the price of these instruments to increase.

Then the supply. The number of publicly traded financial instruments is not static, especially not in 2020. To start, companies can issue extra debt in the form of new bonds. Second, private companies can seek public listing. And third, publicly listed companies can issue new shares to raise extra capital or, more opportunistically, to capitalize on their high market valuation. Last year, this resulted in a large increase in the supply of financial instruments. New corporate bond issues in the US were up 35% during the first 11 months of 2020, USD 1100 bln worth of new listed equity was issued worldwide during the same time, up 60% from the previous year. North America accounted for 455 bln, Europe for 150 bln and Asia for 458 bln. Approximately two thirds of that capital was raised with new issues by existing listings, the rest was raised through new listings in initial public offerings (IPOs). Looking more closely at these IPOs, two factors deserve specific attention.

Every IPO comes with a lock-up period, often 180 days, during which time so called ‘insiders’ are barred from selling their stocks. When the lock-up ends, the number of tradable stocks increases significantly. The expiration of lock-up periods was an important driver for bursting the dot-com bubble (2001/2002) and we are currently monitoring these expirations as market risks.

Among last year’s IPOs were many Special Purpose Acquisition Corps (SPACs). SPACs are empty listings used by so called ‘sponsors’ to buy other companies. But exactly which companies to buy, is yet to be determined at the time of the IPO. 322 SPACs were announced last year, raising an unprecedented USD 87 bln. By comparison, in 2019 SPACs raised USD 16 bln. Track records of SPAC deals are mostly disappointing, partly because the sponsor has a strong incentive to make a transaction within a predetermined time frame. The funds raised during the IPO are often invested in companies with little or no history and inflated earnings forecasts. We interpret this phenomenon in the markets to be an indication that investor expectations are high strung.

To summarize, while a record number of new financial instruments were brought to the markets in 2020, the even higher inflow of capital has led to short term higher valuations. Nevertheless, long term equity pricing will be determined by company profits. We remained critical at valuations last year and used the correction of last March to buy equities with a relatively low valuation. Also, later in the year, we reduced positions in equities with sharply risen valuations. We do not expect monetary expansion to continue to outpace the increase in supply of financial instruments and are confident that our strategy will bring the desired relative long term results.

Fixed income and cash

Currency exposure in the bond portfolio was reduced last quarter as the risk/reward ratio fell with the lower USD interest rates.

Equities

Since the publication of positive results in various vaccine trails, the so called value stocks have started to catch up. We continue to strive for a prudent combination of value and growth stocks but have used the market rally to reduce or sell positions in particularly challenging sectors, such as for example the Hyatt position.

Listed Private Equity Managers

We maintain a relatively high allocation to these companies, as they seem to profit from the inflow of capital to non-listed assets and markets.

Real estate

We remain underweight in the often highly leveraged real estate sector with particular concerns for sub sectors such as office space and malls.

Commodities

Our overweight position in gold is maintained. Low interest rates and the return of inflation in time should benefit the valuation of this position.