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Please see Active Minds article below from Jupiter Asset Management – received 27/08/2020

Active Minds – 27 August 2020

James Bowmaker – Fund Manager, UK All Cap

Could the FTSE emerge from lockdown fitter, happier and more productive?

The apparent schism between Growth and Value in global equity markets is starkly illustrated by the FTSE 100 Index, said James Bowmaker, Fund Manager, UK All Cap, in a week where a single US tech company rose to become larger in value than the entire FTSE 100.

The FTSE is down around 20% year-to-date, which is worse than most of the European indices and much worse than the US indices. On a three-year view, ignoring dividends, it is only up around 3% over a period when the S&P 500 Index doubled. To make matters worse, the FTSE has had a tailwind over this period due to the weaker pound boosting overseas earnings, although Brexit uncertainty has kept global investors away. Even more embarrassing, the FTSE 100 Index has underperformed the MSCI World Value Index over most of the past three-to-five years.

Why? There are far too few Growth stocks in the index and too much Value. At the start of 2020, banks and oil companies accounted for around a quarter of the index and around a third of its dividends. These businesses faced structural pressures, had dividend payout ratios that were regarded as unsustainably high and were backed by volatile commodities and/or cyclical earnings.

But that was then – what about now? We’ve seen aggressive cost cutting and huge dividend cuts in large caps, James pointed out. Some of the cuts are temporary but the dividend reductions of 50%-60% by the large oil & gas companies are permanent. So, starting from here, the prospective dividend yield for the FTSE is around 4.2% – once dividend resumptions are factored in – a yield close to its medium-term average. Furthermore, the cuts have reduced the imbalance in the index and its payouts so the overall yield from the FTSE 100 Index ought to be more sustainable. Banks and oil now account for around 15% of the index compared with 25% at the start of the year and their dividend contribution is no longer 35% of the index payout but a more reassuring 15%. Meanwhile, pharmaceutical companies, with their more stable earnings, now account for a greater proportion of the index and its yield. For investors worried about the prospects of a derating in growth stocks, James says they could do worse than look at the FTSE as it never had that risk in the first place! 

Talib Sheikh – Head of Strategy, Multi-Asset

Growth rally still has legs

Growth vs Value does indeed continue to be the million-dollar question, echoed Talib Sheikh, Head of Strategy, Multi-Asset. The NASDAQ and S&P 500 have hit all-time highs once again, as the growth and technology stocks that dominate these indices continue to see their share prices benefit from the low interest rate environment and negative real yields. Talib expects this trend to continue for some time to come, as he argues that the prime focus for central banks around the world now is to keep real interest rates as low as possible.

Federal Reserve Chairman Jerome Powell’s speech at the virtual Jackson Hole summit later this week is keenly anticipated. Markets are expecting some guidance on how the central bank will address the issue of low inflation, which has persistently fallen below their 2% target for the last decade. Talib expects the Fed will eventually move towards state-contingent forward guidance where they don’t raise interest rates until reaching a certain target. Given this is a live debate and that real interest rates should remain lower for longer, Talib thinks the Growth rally has further to go. In the multi-asset strategy, Talib and the team are focusing on what they believe are high quality assets in the US and high quality, undervalued cyclical stocks in Asia, which are more attractive compared to Europe.

James Clunie – Head of Strategy, Absolute Return

Markets continue to ignore fundamentals

Executing a valuation-driven process remains challenging in the current market environment, where the Growth vs Value performance gap has reached record levels on many measures, said James Clunie, Head of Strategy, Absolute Return. But James and the team continue to believe that the price you pay for an asset is the most important starting point for returns over any sensible time horizon. James used two stock examples to demonstrate the stark contrast in characteristics of stocks found in the strategy’s long and short books.

First, he used the example of a US burger chain as an example of the kind of stock he looks to short. Through a quantitative lens, it looks like a bottom-quartile stock, with poor quality measures, rapid asset growth, and high issuance of new equity, for example. In terms of its valuations, on a discounted cashflow (DCF) model, if you model in 20% growth for the company over the next seven years, assuming margins that meet the industry best thereafter into perpetuity, you can reach fair value – in other words, when you buy its shares, you’re capitalising an extremely rosy future, and paying up for it today as if it’s already happened (and it’s pricey!).

Directors are selling its shares; meanwhile, short sellers are present, and rising. It’s also had significant broker downgrades over the past month, for 2021 and 2022. There’s a lot of work to be done in terms of its business model. It has had a run of disappointing results, and its latest set of numbers recorded losses. However, despite all of these factors, the company’s shares are only down around 2% year to date.

In contrast, James discussed a global shipping company held in the long book. While its balance sheet isn’t perfect, on a quant level, it’s a top-quartile stock; and on a DCF model, it’s trading at about fair value, depending on which assumptions you make. It has a reasonable shareholder base, and it has had huge earnings upgrades, driven by falling fuel costs. Nevertheless, its shares are down around 1% year to date. While it’s not possible to predict where markets are heading, if the market regime does change in favour of value stocks, James and the team believe there is plenty of upside potential for stocks like this.

Patty Cao – Assistant Fund Manager, Emerging Markets Debt

Window of opportunity opens for emerging market bonds

Emerging market debt has been resilient this year as central banks keep rates ultra-low and along with governments provide ample economic stimulus, said Patty Cao, Assistant Fund Manager, Emerging Market Debt. China’s faster-than-expected economic recovery from the impact of the coronavirus has been positive for the asset class, as has the generally improving trend for global PMI data, she said. US real yields at record lows have led to a weaker dollar, which also is supportive for emerging markets, and there is abundant liquidity in the asset class. Retail flows into emerging market debt funds have been positive since July, mostly in hard currency bonds, though local currency fund flows have risen more recently.

The strategy is overweight in local currency emerging market rates, while hard currency corporate bonds have appealing valuations, Patty said. Corporate bonds in hard currency look attractive compared with sovereigns, offering higher yields with shorter duration. She noted that among emerging market currencies, the Turkish lira and Brazilian real have both suffered declines this month.

Positive developments on a coronavirus vaccine and improving economic growth should provide a good environment for emerging market bonds and support continued fund flows for the asset class, Patty said.

A useful article for getting an insight to the market from market experts within their specified field.

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Charlotte Ennis

28/08/2020