Navigating the post-pandemic world

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The last six months have seen a return to the tech-dominated status quo. The rotation from growth to value that followed the unveiling of successful vaccines last November turned out to be the flash in the pan that cyclical rallies so often are. Far from falling victim to a persistent change in market leadership, the large growth shares that had driven the market higher in the early days of the pandemic came back into favour in the spring. It is the performance of these golden stocks which has largely kept the market rising as the list of concerns has lengthened this summer.

So, this is a timely moment for Goldman Sachs to publish a fascinating analysis of how the current market concentration in just a few dominant companies compares with previous periods in which markets have been similarly focused. They ask: can technology remain the biggest sector and can those dominant companies continue to be good investments?

Technology dominates again

Source: Refinitiv, 1.9.21

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

These are important questions, given the likelihood that overall investment returns may turn out to be more disappointing in the next few years than they have been in the past decade or so. If picking the winners matters more in future than just riding the wave higher, then the answers to them will be key.
Goldman’s conclusions are broadly as follows:

  1. Yes, technology can continue to dominate. In fact, compared with earlier periods of market dominance by, first, finance and real estate stocks (early 19th century), then transport (railway boom) and finally energy and materials (post-WW2), the recent leadership by technology and communications shares is far from unusual. The domination by tech of the new issues market should ensure that the sector continues to have a big market weighting for the foreseeable future.
  2. History suggests, however, that dominant companies are in due course knocked off their perch by younger, nimbler rivals. The list of formerly dominant businesses that have disappeared from view is extensive: Kodak, Polaroid, Xerox, Nokia, Dell to name a few. But there is evidence that the current crop of leaders has learned from their predecessors and is taking steps to ensure that history does not repeat itself. Amazon spent $42bn on R&D last year and Apple nearly $20bn. As a consequence, their sales are growing three times as fast as the market and their margins are twice as high.
  3. Delivering strong investment returns from today’s high valuations will not be easy, though. True, today’s tech giants are not as highly valued as were, for example, the market leaders during the tech bubble or the Nifty 50 stocks in the early 1970s. But history again shows that the returns from these types of market leader do fade over time. Importantly, their relative returns fall away as other, faster-growing companies come along to outperform them.

China - stick or twist?

Should we stay or should we go go? That is the question many investors are grappling with today with regard to China. Everyone knows that the world’s most populous nation is a huge investment opportunity. What some prominent investors are now asking is whether the risks are too great.

At the heart of the question is President Xi Jinping’s drive for ‘common prosperity’ and the wide-ranging regulatory crackdown in a range of sectors that has accompanied his bid to build a fairer and more productive economy. This has seen government interventions in high profile IPOs and clampdowns on sectors and companies that have been popular with foreign investors. Evergrande has made investors more fretful still. Investing in China has started to look very unpredictable.

But China bulls are unfazed. The country’s ‘best decades are ahead’ says Howard Marks at Oaktree Capital Management. ‘This is not a return to Maoism’ says hedge fund king Ray Dalio. Government intervention is nothing new in China, they add. And the recent moves do not derail long-term structural trends like the emergence of China’s middle class.

What’s clear, however, is that understanding Beijing’s motivation and agenda is key. Being on the right side of government policy and seeing which way the regulatory wind is blowing are essential. Investing through experienced China hands, with a big analyst presence in-country, is a good starting point.

The end of cheap money

Only a few months ago, the central banks in Europe, the US and Japan were as one - the threats to the global economy remained significant and they were determined to provide monetary stimulus for the foreseeable future. As we head into autumn, the mood music has changed. The concern has shifted from growth and recovery to inflation in a way that was hard to imagine in the spring.

Interest rates: ready for take-off

Source: Refinitiv, 30.9.21

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

At the Federal Reserve’s most recent meeting, Jay Powell, the Fed’s chairman, made it clear that he is ready to call time on the US’s $120bn a month asset purchase programme. The official announcement of this ‘taper’ will almost certainly come in November and the stimulus will be wound down by the middle of next year. Then all eyes will turn to when interest rates start to rise.

The Fed, which was adamant that inflation was ‘transitory’, has changed its tune. The central bank now recognises that price rises are more persistent than it thought they would be, and it’s prepared to act a bit sooner than expected to ensure that inflation expectations don’t usher in a wage-price spiral.

Over here, the Bank of England is, if anything, even more determined. Although inflation is still much lower than it is in America, the Bank expects it to rise to over 4% this year and to stay there for much of next. The inflationary drivers in Britain are different from those in the US, with Brexit a unique additional problem, as we have all witnessed recently in the queues outside petrol stations. The latest minutes from the Bank of England point to a first rise in interest rates as soon as February.

In some emerging markets, the tide has already turned. Interest rates are already on the up in countries like Brazil and Hungary, with the OECD also warning about the outlook in Argentina, Russia and Turkey too. Energy and food costs are more problematic in these countries than in the developed world and both have seen sharp rises recently.

What impact will this have on financial markets? It is hard to tell. No-one can pretend they have not been warned but stock markets never respond well to monetary tightening, even when it has been well flagged.

The spectre of ‘greenflation’

When we look at environmental, social and governance (ESG) focused investing, it is often through an ethical lens - how to make money while doing the right thing. However, as we run up to the COP26 climate summit in Glasgow in November, it is becoming clear that global warming and the steps we take to counter it in the years to come will also have a big impact on how we allocate our investment assets and the returns we should expect from them too.

Fighting climate change could stoke inflation

Source: Fidelity International, October 2021

Investors already try to factor in so-called macro themes and risks into their models about which investment strategies will be most profitable. Until now, however, these frameworks have not really considered climate as a major consideration on a par with geopolitics, monetary policy and structural shifts in the balance of economic power, for example from developed markets to China. That’s now changing.

Our colleagues in Fidelity’s investment team have been crunching the numbers on climate change on the basis of assumptions about two different sets of risks - physical ones (such as extreme weather events, business disruption, asset destruction and migration) as well as so-called transition risks which relate to the measures taken to solve the climate crisis such as regulatory policy, carbon pricing and new technologies.

Their conclusions are sobering. They suggest that investors are underestimating the likely impact of climate change on both growth and inflation, downplaying its likely magnitude and its geographical reach. There are risks and costs to both acting now and to delaying. In the long run, not acting now looks the more expensive option, with a big hit to global GDP in the decades ahead. But hitting ‘net zero’ targets by 2050 is not costless either. The so-called ‘greenflation’ that we have started to see in the price of natural gas, as dirtier fuels are phased out, could add to other inflationary forces in the next few years.

Fund picks - how did they do?

We’ll have a fresh stab in a few weeks’ time at what we think will be the picks of the Select 50 for 2022. In the meantime, let’s look back at this year’s selection of funds after nine months. It’s been an acceptable year to date. The chart below shows the five picks alongside the MSCI World index. It’s not the best comparison for all of the funds, but it provides a broad guide to how the picks have done.

Two have done better than the global benchmark, two are roughly in line. The worst performer, the Foresight UK Infrastructure Income Fund, was selected for its income, which it has delivered, so I’m less fussed about the relative price performance. Fidelity UK Select and Stewart Investors Asia Pacific Leaders Sustainability have kept pace with rising global markets.

The decision to include a mixture of growth and value styles paid off. The shift back to a more defensive approach is particularly clear from the performance of the Brown Advisory US Sustainable Growth Fund which moved from the back of the pack to the front in four months. But it’s level pegging with Fidelity Special Situations, a value-focused fund. Balance and diversification have been helpful - as ever.

A solid first nine months

Source: Morningstar, 30.9.21 bid to bid with income reinvested in GBP terms. Excludes initial charge. Figures rebased to 100 on the chart as at 1.1.21

(as at 30 Sept)
2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
Fidelity Special Situations 19.1 6.3 -3.1 -22.5 47.0
Fidelity UK Select 11.7 4.8 6.8 -10.0 25.7
Stewart Inv Asia Pac Leaders Sustainability 4.3 13.8 5.0 8.5 24.5
Brown Adv US Sustainable Growth - - - - 28.5
Foresight UK Infrastructure Income - - 16.2 -0.3 5.6
MSCI World 18.9 11.8 2.4 11.0 29.4

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in emerging markets can be more volatile than other more developed markets.

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