Will the market rotation be short-term?

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April, 2021

 

Technology is maintaining its market dominance – boosting even non-technological companies – while oil companies face increasing challenges over sustainability demands and the threat of inflation is returning to economies. Here is what the team at Walter Scott thinks this all means for equity markets and returns in the months ahead.

Even as value returns to investors’ favour, the team behind Walter Scott’s International Stock Portfolio maintains high conviction in their chosen holdings. Over the opening months of the year the global market rotation towards value stocks, along with more cyclical parts of the market was to the detriment of what Walter Scott sees as high-quality growth stocks.

Given the strong gains since the market slump of just over a year ago, Walter Scott believe it is likely investors will be sensitive to the ebbs and flows of data regarding the pace and extent of economic recovery.

Economic and political uncertainty is a constant these days but the prospects of higher rates and inflation are not concerns Walter Scott managers have had to consider in recent years. Today, both issues are prominent. “The market rotation that began last year reflects higher yields and an expectation of growth and with that, the prospect of inflation. That is an environment that benefits cyclicals and banks and we have noted recent share price moves in those sectors reflect that view of the future.”

Caveat emptor

Overall, from a sector position, the portfolio’s position in technology firms was the most supportive over the opening quarter of the year. In particular, the investment team highlighted a Taiwanese multinational semiconductor manufacturer as a strong performer. Cybersecurity represents an ongoing driver of returns in the tech sector with companies reporting an uptick in revenues in their part of their business or engaging in M&A.

“Another long-term growth vector that remains very much intact is factory automation. The challenges faced last year of keeping production lines running and supply chains intact only strengthened the case for automating.”

Healthcare and industrials lagged over the quarter while limited exposure to strong financials and energy sectors hurt relative returns.

“The financial sector, notably banks, commodity producers and highly leveraged companies were areas the ‘faster money’ focused on in Q1. We are absent from these areas and unapologetically so. Although this has weighed on short-term relative performance, and may continue to do so for a period, it will not persist indefinitely.”

According to the investment team at Walter Scott, with economic prospects brightening, and perceived government backstops in place supporting companies, it is unsurprising heavily indebted companies have seen their share prices rally.

“Caveat emptor. It makes little sense to assume that the corporate sector will return en masse to the pre- Covid operating environment. Investing in companies with questionable financial structures on the basis of an improving macro back drop may well prove to be reckless.”

Walter Scott maintains its position to avoid banks, primarily on the back of their opacity, making analysis challenging, according to the group.

When it comes to oil though Walter Scott’s investment team feel slightly different. In the past, the team note, they have been able to find high quality, compelling candidates for investment. There the team note, reward for outstanding production growth profiles, global scale and technological leadership was justified. “However, with the added need for a financially credible strategy to transition business models to a more sustainable future, finding long-term growth candidates in this industry has become more challenging.” The fund’s Japanese holdings were the weakest over the quarter and detracted from relative returns while Europe ex-UK stocks were also weak.

Vaccine influences

The investment team at Walter Scott note that whether or not expectations of global economic recovery this year continues has a lot to do with politics and more specifically, the vaccine roll-out in various regions.

“Daily reports on vaccine numbers, across the US and Europe in particular, will continue to come under close scrutiny. In turn, many will be keeping a very close eye on economic data looking for signs of the anticipated flood of pent up demand. The pool of savings needed to fund that demand certainly exists but the extent to which it will be spent, and when, very much remains an open question. It is also very difficult to judge whether this demand will be the beginning of a sustained economic recovery or a more temporary phenomenon.”

Elsewhere, the team at Walter Scott note the flow of company results, alongside their own dialogue with company managements, presents a clearer and more reassuring picture. While Walter Scott agrees the on-going challenges faced by companies should not be underestimated, there has been a reassuringly strong common strand of resilience the investment team is seeing. Using digital means to transform and adapt businesses is one such positive.

Note: These are universal comments

Risks:

All investments involve some level of risk, including loss of principal. Certain investments have specific or unique risks. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.

This material has been provided for informational purposes only and should not be construed as investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall.

Views are current as of the date of this publication and subject to change. This information contains projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Walter Scott & Partners Limited (“Walter Scott”) is an investment management firm authorized and regulated in the United Kingdom by the Financial Conduct Authority in the conduct of investment business. Walter Scott is a subsidiary of The Bank of New York Mellon Corporation.

BNY Mellon Investment Management is one of the world’s largest asset managers, with $2.2 trillion in assets under management as of March 31, 2021. Through an investor-first approach, BNY Mellon Investment Management brings to clients the best of both worlds: specialist expertise from eight investment firms offering solutions across every major asset class, backed by the strength, stability, and global presence of BNY Mellon. BNY Mellon is the corporate brand of the Bank of New York Mellon Corporation and may be also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally.

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MARK-185490-2021-04-22