22 December 2020
Covid-19 continues to supercharge structural shifts across multiple sectors, resulting in polarisation between winners and losers. GAM Investments’ Amanda Lyons, Niall Gallagher and Ali Miremadi review an extraordinary year of change and discuss the importance of selectivity in equity markets as we move into 2021.
The Covid-19 crisis has greatly accentuated and accelerated several key structural trends in 2020, including the rapid migration to digital technologies, an offline to online e-commerce switch and an even greater emphasis from global leaders and companies on decarbonisation and a ‘green recovery’. As vaccination programmes progress through Q1 2021, restrictions will / should be rolled back and consumer confidence is likely to pick up with the prospect of a return towards economic normality. As a result, while major structural trends are unlikely to be derailed, many winners of 2020 may not necessarily represent the best opportunities for 2021, while the out of favour companies of 2020 are already becoming more attractive. GAM Investments’ managers Amanda Lyons, Niall Gallagher and Ali Miremadi believe significant opportunities exist within in their respective asset classes heading into 2021, although careful stock selection will remain key.
Amanda Lyons – Investment Manager, Technology Equities, on Disruptive Growth
The Covid-19 pandemic led to a polarisation of the market between so-called Covid-19 winners and losers. Many tech names fall within the winner category. 2020 saw a significant shift towards e-commerce and digital at the expense of offline, with many companies commenting that they experienced the equivalent of several years of growth in just a matter of months. But perhaps the most prominent theme of the year has been the pivot towards working from home / remotely. Technology became the primary focus in the boardroom, as firms ensured that their systems were robust enough for entire workforces to operate remotely. Zoom quickly evolved from being a little-known player in the conferencing software niche to a verb used in common parlance.
While many of the winners from 2020 are now on higher growth paths than pre-crisis, in many cases we believe they do not necessarily represent the best opportunities for 2021. Instead, some of the less loved companies of 2020 are becoming more attractive as Covid-related restrictions are lifted. For almost all of 2020, travel ground to a halt and understandably both business and leisure travel companies suffered. Recent survey data suggests the number one activity people want to do post crisis is travel, particularly for leisure, implying there is huge pent up demand. At the same time, consensus estimates do not expect a full recovery for the travel industry for several years. This gap between recovery estimates and pent up demand offers opportunity for investors.
Beyond the potential rotation in cyclicals, we are at an inflection point for a more permanent structural shift. We are moving from a world with billions of devices (Digital 3.0) to a world with trillions of devices (the Internet of Things era, Digital 4.0). Advancements in artificial intelligence (AI), the ability to process, use and store data, and the roll out of 5G means that this is now possible. This theme is playing out in multiple verticals, most notably healthcare, transportation, robotics and the automation of knowledge work. At the heart of Digital 4.0 is the cloud. With penetration of the cloud still below 10%, the opportunity ahead is enormous.
In our view, 2020 will be regarded as a turning point where digital transformation was pushed to the top of priority lists. Companies who successfully embed technology at their core in 2021 and beyond will set themselves apart from those who do not. We are already seeing polarisation occurring, and this is only set to increase.
Niall Gallagher – Investment Director, European Equities
Once Covid-19 vaccination programmes progress through Q1 2021, we expect restrictions will be rolled back, consumer confidence will pick up and economic activity will accelerate markedly in those areas that have been hit hardest. Many consumers have not lost their jobs due to government funded job retention schemes, and with restricted avenues for consumer spending in 2020 this resulted in a historically large build up of cash in consumer bank accounts and record savings rates. We expect much of these supernormal savings to be spent in 2021. However, the rising tide is not going to lift all boats – there is likely to be continuing high dispersion of returns due to stock specifics.
We therefore remain highly selective. European stocks with strong franchises, high over the cycle returns and robust balance sheets should emerge from this crisis competitively strengthened, in our opinion. A strong economic recovery will not derail those structural trends we have been discussing for some time and which were supercharged in 2020 – the rise of the Asian middle class, offline to online commerce switch, digital transformation, decarbonisation and the greening agenda. In many respects the epicentre of growth will be in those parts of the world undergoing the most dynamic change. However, there is likely to be more stock selectivity in European equity markets and opportunities in stocks / otherwise good businesses in areas that have been disproportionately hit by the Covid-19 crisis. Structural trends may not dominate headlines for a few months, but they will continue to drive compounding operational growth for the specific well-positioned companies we invest in.
Ali Miremadi – Investment Director, Global Value Equities, on US Equities
The set up for US equities going into 2021 is driven by several powerful drivers seldom seen all at once: a likely strong economic rebound enabled by the roll-out of vaccines; ongoing extraordinarily accommodative monetary policy; with additional fiscal stimulus also likely. On this basis alone, the outlook for equity returns is positive. Set against this are two other particularly important points: the high valuation of equities on any historical precedent, and the outlook for inflation. Our expectation is that in the short term, the recent catch-up trade of value and cyclical sectors of the market outperforming is likely to continue but that quite soon, perhaps as soon as the first quarter of 2021, market returns will become more idiosyncratic and stock specific. The logic for this is simple. Since the global financial crisis (GFC), equity returns have been largely beta and factor driven. In brief, in a low growth and very low interest rate world, the two important calls were to be long risky assets such as equities, and within equities to have as much exposure to growth as possible. The single biggest driver of this was the ongoing fall in long-term interest rates from 2008 to 2020. It is arithmetically impossible for this to repeat itself, which means that we cannot expect the same relentless upward revaluation of growth-orientated equities going forward. Instead, we expect alpha generated by stock picking to become the dominant feature of performance in the US equity market going forward.
In the short term, profit margins are likely to trough in the fourth quarter of 2020 but should recover rapidly from here, with operating leverage turning sharply positive as the economy reopens. It seems unlikely that wage pressure will be meaningful given the employment outlook. There are several potential policy moves which could influence this picture. President elect Biden is in favour of raising the national minimum wage to USD 15 per hour, as well as raising federal corporation taxes from 21% to 28%. It is possible that a less mercantilist foreign trade policy may also reduce aggregate tariffs from 3.2% currently under this administration. The results of the double Senate race in Georgia in early January will be important in this context.
We expect market breadth to widen, as big tech is unlikely to be so dominant in overall S&P 500 earnings growth going forward, as has been the case during 2020. Early in 2021, industrials and materials should perform well, in our view. We expect the relative outperformance of companies with strong ESG credentials to continue. Healthcare should do well coming out of the pandemic, aided by the removal of election-related policy uncertainty. Some pockets of tech are clearly very expensive by any measure, but we are still finding selective opportunities, with exposure to multi-year themes such as 5G and the Internet of Things. Exposure to electric vehicles is also available at reasonable valuations. We currently favour housing-related equities; years of underbuilding has hit supply, while we have seen strong demand driven by record low mortgage rates, which helps affordability. In addition, strong household balance sheets coming out of the pandemic helps fuel confidence. The recent shift in demand from city to out of town is also good for homebuilders focused on houses rather than city apartments.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Past performance is no indicator for the current or future development.