This too shall pass

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Many of us will have breathed a sigh of relief as Big Ben counted 2020 out and ushered in a hopefully brighter new year. It’s been a challenging 12 months, but such periods always bring their fair share of lessons too. Here are some of the things I learned in 2020.

The first is that, while crises invariably present opportunities, you can’t just wait for them to land in your lap. You have to do something to capitalise. As my old friend Jim Slater used to say to told-you-so, rear-view investors, ‘the difference is, I did it’. While we tend to caution against market timing, sometimes you really do have to grit your teeth and take the plunge. March 2020 was one of those moments.

Having fallen 30% since the peak, there was every chance that the market would repeat its 50% drops in 2000 and 2008 but with each passing day the odds were stacking up in our favour. Sometimes, you just have to go for it.

The second lesson I learned last year is that markets and economies are not the same thing. They march to a different drumbeat. Stock markets look to the future while economies operate in the here and now and economic data measures the past. This is why the stock market traced out the V-shape it did even as the medical and economic data deteriorated.

Widespread vaccination should allow a rapid return to previous levels of activity, with the gap bridged by massive fiscal and monetary stimulus. That will not come without a cost, of course, but investors are working on the basis that this will be a problem to face another day.

The third lesson I take from last year is that, as investors, we have to follow our instincts - sometimes the obvious decision is the right one. This is well illustrated by the sector chart here which shows how the divergence between the pandemic’s winners and those industries hardest hit by Covid was evident immediately and persisted throughout the market’s fall and subsequent rise. Investing in stay-at-home beneficiaries and avoiding travel, hospitality and retail stocks did not require any great insight. It was the consensus view. But it was the difference between a good year in the market and a bad one.

Technology leading the field

Source: Refinitiv, as at 18.12.20. Rebased to 100 at 19.2.20

%  (as at 31 Dec) 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
Technology 10.3 38.7 -7.5 42.7 46.9
Telecoms 1.7 5.0 -14.2 11.6 6.3
Health Care -7.8 20.6 -1.9 22.8 16.7
Financials 3.8 22.3 -15.6 20.6 -5.7
Consumer Discretionary 0.9 23.8 -13.9 23.2 25.8
Consumer Staples 0.2 21.6 -18.1 18.3 3.9
Industrials 9.1 26.8 -17.6 27.8 12.2
Basic Materials 17.9 27.8 -20.6 15.1 20.3

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.

Lesson number four. Be prepared - as the late Jimmy Goldsmith said: ‘when you see a bandwagon, it’s too late’. In November, the coincidence of the US Presidential election result, increased confidence about Brexit and the arrival of a vaccine provided the catalyst investors needed to rotate into the most beaten-up cyclicals that had borne the brunt of the sell-off in March. Some of the movements that month were remarkable. The likes of BA-owner IAG and cruise operator Carnival rose more than 50% in a few weeks.

The final lesson was the realisation that, while things tend to be less good than we hope and less bad than we fear, sometimes they really do change completely. The era of market-focused globalisation that grew out of the chaos of the 1970s and prevailed for 40 years is drawing to a close. The consequences of this will not be altogether positive for the owners of capital (such as, I suspect, everyone reading this) and we will all need to plan carefully for the headwinds ahead, including but not restricted to higher taxes.

Fund picks: surviving an extraordinary year

Defensive funds outperformed in 2020

Source: Morningstar, 31.12.20, bid to bid with income reinvested in GBP terms. Excludes initial charge. Figures rebased to 100 as at 1.1.20

%  (as at 31 Dec) 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
Fidelity Global Dividend 22.6 6.6 2.2 20.5 6.0
Fidelity Select 50 Balanced - - - 12.4 5.3
Liontrust UK Growth 18.1 14.2 -6.1 19.9 -8.3
Artemis Global Emerging Markets 37.7 26.0 -7.7 14.0 -0.4

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. Before you invest in a fund, please ensure you have read Doing Business with Fidelity and the Key Information Document (KID) relevant to your chosen fund.

At this time of year, I turn to our fund picks for the previous 12 months, usually with some trepidation. 2019 was an easy year to report on; 2020 was always going to be a bigger challenge. However, with some relief I can report that the four funds highlighted a year ago have navigated a trying period in the market with acceptable resilience. We were right to be cautious at the end of a strong year in the markets in 2019 and to position ourselves defensively for 2020, albeit in blissful ignorance of what actually lay ahead.

The two most defensive funds, both from Fidelity, the Select 50 Balanced and Global Dividend, served up modest gains for the year as a whole. All credit to both managers. They pretty much made up for the failure of both Liontrust UK Growth and Artemis Global Emerging Markets to fully retrieve early losses by the end of the year.

Looking into 2021, I expect three themes to matter. Sustainability has proved to be an important distinguishing characteristic of the best-performing funds in 2020 and this trend looks likely to continue this year. Three of the five funds I am highlighting today are explicitly focused on environmental, social and governance factors.

The Brown Advisory US Sustainable Growth Fund looks for businesses with a sustainable business advantage. It is concentrated and has a strong valuation discipline. The Stewart Investors Asia Pacific Leaders Sustainability Fund has a similar focus, looking for ‘socially useful’ businesses in the Far East. It manages its emerging market risk with a large and mid-cap bias. The third fund in this category combines sustainability with my second theme, an income focus. Foresight UK Infrastructure Fund aims for a 5% income stream (not guaranteed), delivered via investments in real assets in renewable energy and other infrastructure.

The third theme is what I hope, finally, will be an end to the UK discount caused by the cyclical bias of the FTSE 100 and the Brexit situation. The UK is almost a pariah market today and this sets my contrarian antennae twitching. I have chosen two UK funds, both from Fidelity, to hedge my bets on the unanswered growth or value question.

Fidelity Special Situations is the value play, focused on unloved companies entering a period of positive change. Fidelity UK Select is the growth option that will perform better if strong brands and robust balance sheets continue to garner support.

Key questions as we move into 2021

This divergence in performance between the growth and value styles was one of the biggest determinants of investment returns in 2020. As the chart below shows, the jaws between the two have widened yet further in the past year as investors have sheltered in companies with a track record of delivering earnings through thick and thin. If you had invested £100 in the S&P 500 growth index a year ago, it would be worth £131 at the time of writing, compared with £97 for the same amount invested in the value index. Over ten years, shown here, the returns from growth have been almost double those of value.

For value to outperform growth in 2021, we will need to see a significant pick-up in economic activity on the back of an effective vaccine, with consequent increases in interest rates and bond yields. These are all possible, even probable, but it is worth remembering that some value sectors, such as banks and oil & gas, are cheap for a reason. They face long-term headwinds and, short-term, there is still much that could go wrong with the ‘back to normal’ thesis. A balanced approach between growth and value styles continues to make sense.

Another year of outperformance for growth investing

Source: Refinitiv, 18.12.20, rebased to 100 at 18.12.10

(as at 31 Dec)
2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
S&P Growth 5.8 25.3 -2.7 30.7 31.4
S&P Value 14.5 12.9 -12.3 29.6 -1.6

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.

While I have backed the sustainability theme with my recommendations this year, I recognise that there is a danger that investors become excessively focused on what is, after all, just a proxy for good and prudent management in a changing world. There is a risk that a kind of sustainability bubble starts to form in 2021 and I will be watching this closely.

The chart here of the performance of renewable energy stocks compared with the overall global stock market is instructive. When markets start to head up the page in this way, it is wise to tread carefully but trends like this can persist for a long time, especially when they are backed up by sound underlying fundamentals.

Investors focus on sustainability

Source: Refinitiv, as at 31.12.20

%  (as at 31 Dec) 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
World Renewable Energy Index -15.7 11.8 -9.9 58.6 179.1

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.

As we move into 2021 there are a few issues that we know will be important but the outcome of which remain hard to predict. The first is whether this year will start to see a return of inflation. The unprecedented scale of monetary and fiscal stimulus this year argues for higher prices but in the short-term there is no evidence of their imminent arrival. Longer-term it feels like the path of least resistance for politicians grappling with levels of debt that we have never experienced in peacetime. Developed countries that print their own currencies won’t default and cannot feasibly impose the austerity that would be required to pay the debts off. That leaves only one possible solution - inflating them away. Inflation is a killer for long-term investors.

Actually, there is one other partial solution to the debt question. While tax hikes may not be a realistic solution to paying down the national debt, and arguably would be counter-productive because they would stifle the economic growth that is the best way to dig us out of this hole, they are undoubtedly politically expedient. I view the March budget with some foreboding and would urge investors to do what they can to protect themselves from what might be a truly un-Conservative assault on our pensions and capital gains.

My conclusion, as ever, to the lack of clarity that all investors face is the supreme importance of diversification. Avoid home bias. Don’t put all your eggs in one basket. Do what you can to make sure you survive to fight another day, whatever Mr Market throws your way.

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