Welcome to our global equities outlook and insights for 2021. We provide our investment team's viewpoints on the global equities market with specific focus on global small and mid-cap equities, and look at the opportunities and risks for investors as we make our way through the first quarter of the year.
Global equities outlook - looking beyond the large tech companies
The global equities market continues to look optimistically into 2021 with many positive factors that remain supportive of rising markets moving forward, including unprecedented levels of fiscal and monetary stimulus, low/negative interest rates, the potential for high vaccine efficacy, pent-up demand as economies re-open, and cost cutting activities across many corporates supporting margin expansion as volumes recover. With regards to our portfolio, we are also constructive, but are acutely aware that the culmination of events in 2020 has left behind a lopsided economy.
- Pent up demand leading to growing pipelines and stronger conversion rates, the potential to accelerate sales - management at financial institutions have recently highlighted a growing pipeline as many financial institutions have begun increasing investments to upgrade their banking software platforms and adding additional customer centric functionality. An acceleration in the conversion of deals will be a significant catalyst this year.
- Operational leverage as businesses recover - cost cutting activities across many corporates are supporting margin expansion in 2021. There is excellent earnings leverage in the portfolio with EPS growth at the portfolio level currently over 14%.
- Sell-side (or consensus) expectations often lag in an upgrade cycle - this positive medium-term outlook is yet to be factored into market expectations.
- Valuation reversion of undervalued quality sectors - two of our overweight sectors are Health Care and Consumer Staples. We strongly believe this allocation will be a key contributor to returns given the fact that the relative valuations of both these sectors are near ten-year lows when compared to the broader benchmark.
- Various other risk factors - this environment could easily be disrupted by further political instability, trade disputes, tech related regulation, the prolonged effect of the pandemic, the potential reduction of stimulus or rising interest rates which have already started to move up at the long end of the curve.
- Valuation discipline essential given recent wild moves in the market - we are confident that with our discipline around valuation, reducing portfolio volatility and trimming stocks that are driven by momentum, that we will be well placed to navigate through future periods of uncertainty.
How are we navigating the global small and mid-cap market?
We remain broadly constructive on the outlook for global small and mid-cap (SMID) equities. The recovery from the March 2020 lows has been swift but there are still many positive factors that remain supportive of rising markets moving forward as discussed above. SMID equities should benefit greatly from the excellent earnings leverage that we typically see coming out of economic downturns.
Overall, we believe there are still many excellent opportunities within global SMID equities for active fundamental investors to generate favourable long term returns by buying quality companies without taking undue valuation risk. Global SMID equities will continue to play an important long term growth role in investors’ portfolios in 2021 and beyond.
Risks and opportunities for investors
In recent months there has been a rising chorus of market commentators that have been warning of a market bubble forming. While identifying bubbles, and especially the timing of them bursting, is an extremely difficult task, that's why we believe it is important to distinguish between the different areas of the market which are most at risk. We still believe there are many quality companies with attractive long term fundamentals that represent good value but these should be distinguished from some of the speculative risk taking that is occurring in the market today. Much of the risk taking and momentum based trading is especially prominent in many unprofitable companies that are now trading at extreme valuations and pose a high risk of investor losses in the years to come.
We are seeing a wide range of signs that fundamentals are taking a back seat to speculation in the current market, including:
- The massive surge in special purpose acquisition company (SPAC) IPO’s, which raised over US$80 billion in 2020, far exceeding the amount raised in the past decade combined.
- Put/call option ratio at 20 year lows and 5 of the 10 largest call option volume days in history occurring in January 2021.
- A hot IPO market, which included 480 IPO’s in the US in 2020 compared to 406 IPO’s at height of dot.com boom in 2000.
- A big increase in the prominence of retail investors, driven by factors including the ‘Robinhood’ phenomenon (zero trading fees), stimulus checks, increased unemployment benefits, loan holidays, and increased disposable income due to shutdowns and reduced spend on travel and leisure, as well as the spruiking of stocks taking place on various social media and online forums.
- Huge share price appreciation in many thematic stocks including companies with exposure to areas such as EV’s, hydrogen fuel cells, solar energy, bitcoin/blockchain, and short squeezes in many of the most shorted names.
- A massive surge in trading activity in stocks with extremely high valuations – as at 21 January 2021, stocks with EV/sales ratios >20x made up approximately 25% of US trading volumes compared to approximately 1% in 2018.
- Outperformance of unprofitable stocks - the unprofitable companies within the MSCI World SMID Cap Index based on trailing 12 month net income (~27% of total index) have outperformed their profitable peers by 22% from 1 November 2020 to 26 January 2021.
While we still believe there are plenty of good opportunities for active stock pickers to generate favourable long term returns, investors should be very cognisant of the risk profile of any investments they are making. In our view, over the long term the main driver of stock prices are company fundamentals (i.e. balance sheets, real earnings, competitive advantages, cash flows, valuations etc.) and in times like these when speculative activity is rife, we believe that quality focused fundamental investing is as important as ever in order to provide downside protection during bouts of market volatility, and to capture the full benefits of long term earnings compounding.
