December Update - “Rule Britannia!”

December 8th 2020

Disclaimer: this report does not constitute investment advice and is not a forecast. Past performance is no guide for the future.

We haven’t broken out the champagne yet and are certainly not resting on our laurels, but Q4 has so far seen a remarkable recovery in markets. These moves have been driven by vaccine momentum and a general confidence that we are now at the beginning of the end of the Corona recession. Since the Q3 market low at the end of October we have seen a 15% recovery in equity markets, and a rotation into value. This was driven by the US election being (almost!) behind us, and some positive efficacy data on three different vaccines for COVID-19. In addition, the Pfizer vaccine has been approved for use in the UK and is already being deployed. This fact gives us greater confidence in our base case of a widespread global vaccine rollout in 2Q 2021 at the latest, a timing which could easily be exceeded in the UK. As a result, the developed world should be able to return to pre-pandemic GDP and earnings levels by the end of 2021.

In the past month, the MSCI UK equity market is up 10%, outperforming most other markets, and beating global equities by 3%. The sector moves here demonstrate that the strongest performers in the past month have been the value sectors— those trading cheaply, or below their intrinsic value. As mentioned in our previous updates, 2020 performance has been driven by large cap, US and tech stocks. We expect the recovery to broaden out, offering greater opportunities to move into some of the cheaper and more cyclical parts of the market. Vaccine news flow and the start of the transition of power in the US have clearly been strong drivers of this risk-on stance and the rotation into value, but there have also been some sector-specific reasons. Energy names have been boosted by the oil price, which has recovered to USD48/bbl. For the MSCI UK index we anticipate approximately 40% earnings growth in 2021.

It's not just us who’s turning more bullish on the UK. Throughout November commentators generally revised up their expectations. Capital Economics said that GDP may “rise to its pre-virus level a year earlier than otherwise expected in early in 2022 rather than 2023”. Douglas McWilliams, chairman of the Centre for Economics and Business Research, said that GDP growth next year “might be double-digit or close to that” and may have recovered all the lost ground since March possibly “as early as mid-2021”. Ian Tew, at Barclays, said: “Arguably the pound has been undervalued since 2016”.

The investment banks to are jumping on the bandwagon! UBS has positioned the UK as its most favoured market given its 30% forward price-to-earnings discount to global equities and its 40% earnings growth forecast for 2021. During November Goldman Sachs advised its clients to invest in British shares, predicting that a last-minute “skinny” free trade deal with the European Union would be announced soon. The investment bank also advised clients to “go long” on the pound, predicting that it could rise to $1.44 next year as the UK economy rebounds faster than previously forecast. This is in the context that the day before the Brexit referendum (22nd June 2016) a pound bought $1.48 or €1.31. Almost everyone now agrees that sterling is undervalued. Citigroup, Morgan Stanley and UBS have advised clients to buy British shares.

Looking at the big picture, we believe that investors will increasingly look beyond technology-driven growth stocks which trade on sky-high multiples. Such a move would be beneficial for the UK stock market as international investors rotate back into Sterling assets driven by relative valuations. Meanwhile, the UK market's attractive dividend will grow in 2021, drawing interest from income investors against a low-yield backdrop. The current dividend yield on the FTSE 100 is around 4%, and consensus expects dividends to grow by about 20% in 2021.

So how do we apply this view to our investment thesis? Firstly, we long-term investors so trying to directionally time the market around the daily sequence of vaccine and stimulus announcements that speed up or delay the return to ‘more normal normal’ is probably beyond human or artificial intelligence! We believe that our portfolio which is made up of defensive companies that can grow their earnings in this environment such as Unilever and Smurfit Kappa will weather any further storm well. Added to these is our exposure to an element of recovery that will help our more cyclical stocks like the oil companies. We are beginning to look again at those recovery stocks that will be in a position to dramatically improve their dividends in 2021 as life returns to normal.

We’d like to remind investors that the fund invests in large companies which dominate their industries and have market-leading brands. We believe that these firms will enjoy stronger, more resilient margins than their competitors and as a result their share prices should outperform over the medium to long term. We will use any short-term volatility as an opportunity to build up positions in our highest convictions. This later point is essential in order to preserve capital in volatile markets.

All in all, we are comfortable that the action we have taken to the portfolio during 2020 will deliver more sustainable dividends for our investors, more resilient growth for capital investors and that the market will come our way and income-bearing stocks will once again outperform.

Performance since launch

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