These very same authorities stepped in almost instantaneously to tackle the effects of this shutdown, thereby warding off a financial crisis, even in emerging markets. Given the extent of the plunge in March, here at Dorval Asset Management we opted to hold onto investments and hold out for the recovery, a stance driven by the view that this shock was by and large reversible given both the nature of the crisis and the way it was managed. All our funds were therefore buoyed by the subsequent robust upturn on the equity markets.
Consumers spent massively when the economy opened up again as they drew on income that had largely been upheld by fiscal support – or even bolstered by it, such as in the United States for example. The hospitality, leisure and tourism sectors were hard hit by restrictions, so households redirected a hefty portion of their spending to purchasing goods, as the manufactured goods sector is currently enjoying a massive boom, with retail sales scaling record heights and world trade already making it back to its pre-crisis pace.
World GDP will probably come out on a par with figures this time last year in 4Q 2020, fueled mainly by the Chinese economy. Meanwhile, if we look to developed markets alone, this quarter’s figure will likely still stand 4% short of 4Q 2019 performances, but this is a good sight better than most economists feared in a second pandemic surge scenario, with the OECD projecting a 15% plunge in its June 2020 outlook.
Dorval AM remained heavily invested on the markets as we tailored our investment themes to follow the progress of this economic recovery. In our global funds (Global Convictions expertise), our portfolio managers drew on the digitalization of the economy theme – one of the main beneficiaries in the Covid-19 crisis – then the recovery in Asia and lastly construction stocks. We also maintained significant exposure to Italian bonds. Despite Europe’s difficulties, the continent managed to pull together and partly pooled debt to finance a vast €750bn stimulus package geared particularly to buttressing the weaker members of the bloc.
Economic boom in 2021 and risks set to balance out
With vaccines making it to market and the US elections now past, the skies are clearing for investors and they can now look to the “post” world i.e. post-Covid-19 and post-Donald Trump. Entire segments of the economy are opening up again as the virus is brought under control, and this amounts to the equivalent of a massive stimulus program that will run right throughout 2021, adding to both existing and planned monetary and fiscal support, as well as the ongoing trend to household dissaving, which kicked off in June 2020. Joe Biden’s election will further fuel this climate of confidence and help the recovery garner momentum worldwide. Tensions will continue to run high with China, but world trade should no longer take such a beating from border duty meddling and presidential revenge tweets. In light of these political events on the one hand, and developments in the pandemic situation on the other, we bolstered the weighting of cyclical themes in our portfolios at Dorval Asset Management, upping our exposure to the European markets in particular – including small-caps – and to sectors most severely affected by the Covid-19 crisis, as well as the commodities theme.
Risks obviously hang over this now broadly agreed scenario, for example the Covid-19 pandemic may turn out to last longer than expected and be more difficult to get under control than anticipated, despite vaccines now coming on the market. There is also a risk of fiscal fatigue and an excessively swift halt to rescue programs as a result of potential excessive concerns on the surge in public debt. However, there seems to be little justification for this concern as the economic recovery and low interest rates should help governments keep a handle on their public debt figures. Conversely, a win for the Democrats in Georgia on January 5 could further fuel fiscal stimulus at a time when temporary bottlenecks are already building and pushing up commodities prices, with the situation powering risks of a disruptive upsurge in long-term rates.
Recovery partly priced in, and valuation differences prompt diversification
Assuming that Covid-19 is gradually brought under control throughout 2021, the question of an upturn in the cycle then also seems to be in hand, as does the issue of short-term interest rates, which the main central banks plan to maintain at a low for at least two more years. So the main questions on the markets now involve our other three analysis cornerstones used in our decision-making process here at Dorval Asset Management:
- Microeconomics. A very small cohort of superstar companies has grasped a vast proportion of world profits over recent years, as the five so-called GAFAM companies snatched up almost 20% of EBIDTA growth for all firms in the MSCI World between 2010 and 2019. Meanwhile in France, luxury goods stocks have dominated spectacularly. However, this competitive advantage temporarily fades when economies emerge from a recession, as the recovery period shores up a large number of companies – the most cyclical – and drives their very robust profit growth for a year or two.
- Valuation. Are equity prices already too lofty? Median valuations worldwide based on the Shiller P/E are slightly high if we look at past figures, but not drastically so. Dorval AM’s analysis thus invalidates the urban myth that stock-markets are climbing on the back of central bank intervention, while equities still actually carry an attractive risk premium vs. bonds. The real issue at stake here is the valuation gap between winners (information technology, healthcare, luxury goods, etc.) and losers (financials, energy, etc.) in the changes that have taken place over recent years, and this differential has now hit its widest since 2000. However, this valuation gap should tend to narrow as is often the case during an upswing in the economic cycle (2009/10, 2017).
- Market dynamics. With investor optimism and risk appetite now prevailing on the world markets, caution is the watchword. Hopes are high that vaccines will provide all the answers, so optimism is obviously widespread, and this heightens the risk of disappointment. Additionally, the economic recovery is already well priced in, as reflected by cyclicals’ stellar outperformance vs. defensives in the second half of 2020. A close eye should be kept on indications that the markets are moving into overbought territory in the short term for tactical allocation purposes.
With the economy recovering and interest rates staying low – or even negative –, maintaining sound equity exposure is a natural step, but this exposure must be steered, and plays should be diversified. Star stocks have taken on a considerable weighting in the main stock-market indices, so this quest for diversification requires a move away from these indices and into more active strategies. Dorval Asset Management’s funds’ positioning reflects our focus on broad diversification as 2021 gets off to a start, particularly for funds in our Global Convictions range, which takes highly diversified positions in both geographical and sector terms. These flexible funds will continue to provide scope for steering the trajectory and adapting market exposure rates.
Comprehensive changes for the new decade ahead require adjustments
2021 is poised to mark the end to a recession unlike anything ever witnessed, but the shock experienced in 2020 will still remain in the forefront of many minds going forward, further driving trends that had already been ongoing since the 2008 financial crisis. After the invisible hand paradigm that was all the talk in the 1990-2000 period, we are now seeing the more visible hand of states, along with growing demands from citizens, consumers, and savers on environmental, social and governance dimensions. These shifts have a major impact on each of Dorval Asset Management’s four analysis dimensions that act as the cornerstones for our investment management process, as increasing consideration of the non-financial components of economic activity now pervades all four pillars i.e., macro, micro, valuation, and market dynamics.
As the United States sets out to rejoin the Paris climate agreement, the quality of growth will be judged on the basis of climate goals across the board. The energy transition will pick up the pace, with the ensuing risks and opportunities, as well as all the virtues and contradictions that can bring. Uncertainties include the carbon tax, and both the magnitude and scope for these measures will largely dictate the feasibility of goals for curbing climate change. It will be crucial to closely monitor the degree of China’s involvement, as the country is by far the largest CO2 emitter, outstripping the US and Europe combined, with 10 billion tons. Lastly, pledges to fuel green growth with funding from major stimulus packages will run up against bottlenecks on some commodities, such as copper. In our global funds, Dorval Asset Management’s portfolio managers will address this commodities theme via the relevant firms that successfully pass our ESG screening, as well as through exposure to producing countries’ currencies.
Looking beyond climate aspects themselves, the growing importance of responsible growth will shape the review of an entire series of laws, rules and practices. So in view of these trends, the diversity, skills and independence of companies’ boards, as well as their management excellence – a theme that we are particularly attentive to here at Dorval AM – will be prime qualities in singling out opportunities and avoiding any pitfalls.