How does a post-Covid-19 global equity portfolio look? Andrew Pitts suggests BATS with FAANGS and GRANOLAS have a place.
What a welcome bounce-back stock markets have made since their mid-to-late March lows. In the UK, the FTSE 100 has put on 1,000 points from its low of just below 5000 – a gain of around 20%. But the cost has been a £24 billion hit to dividends from index heavyweights such as BT and Shell, with the pipeline also expected to run dry at fellow oil major BP before long as its debt ratios skyrocket.
In the US, the bounce-back has been the swiftest bear market rally in history, and one that has so far seen the benchmark S&P 500 index gain a whopping 30% from its March low, led by the five tech giants (Apple, Amazon, Alphabet, Facebook and Microsoft), which now account for 20% of US market capitalisation.
Technically speaking, this means the global bear market is over. But that will not provide much solace to equity investors, who are still nursing losses: by way of illustration, to reach its recent high of 7651 the FTSE 100 will need to rise another 27% from here. Are gains of that magnitude likely, or will markets take another coronavirus-linked downward lurch?
So-called quality growth companies and the aforementioned technology giants have led the way back from the depths. Unfortunately, we do not have much in the way of global heavyweight technology firms in the FTSE 100 (or listed elsewhere in Europe) to provide the extra kickstart that the US has had. The blue-chip index’s rise has been spurred by the unprecedented global monetary and fiscal response to the Great Coronavirus Crisis (GCC), and expectations of a V-shaped economic recovery as the world emerges from lockdown.
Whether a recovery is V-shaped or U-shaped, or the world enters a longer recession, quality growth stocks will continue to serve investors relatively well, as suggested in last month’s column. So will “BATS with FAANGS” (acronyms for the Chinese and US tech giants Baidu, Alibaba and Tencent; and Facebook, Apple, Amazon, Netflix and Google parent Alphabet). They propelled markets forwards in the last decade but look set to continue to play an important role in market leadership.
In continental Europe and the UK, we have a new acronym to describe the quality growth shares that, in the view of Goldman Sachs, will prove to be very reliable in the immediate future. These are the “GRANOLAS”, the big European companies with strong balance sheets and reliable dividends that yield between 2 and 2.5%, focused on healthcare and consumer staples, with a smattering of luxury goods and technology.
They are GlaxoSmithKline, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oreal, LVMH, AstraZeneca, SAP and Sanoﬁ.
On conventional price/earnings measures these, and the tech giants further afield, might look expensive after a strong run, but in general they are growing earnings per share, have strong cash flows to invest in the future and, in the case of the GRANOLAS, pay progressive dividends. The latter cohort can be expected to be a solid if unspectacular group to which pan-European and global fund managers will turn for stability.
Yet another acronym doing the rounds puts another tick in the plus column for these shares, if not for equities in general: “TINA”, or “there is no alternative”. Although a somewhat sweeping generalisation, institutional investors have few other places to make a real return. They are now looking at nominal yields of less than 1% on 10-year sovereign bonds around the world, while highly rated corporate bonds are offering little more than that. Despite the huge amount of money being “created” to support the global economy through the GCC, inflation expectations are low, so that will keep the lid on bond yields for a while yet.
Progress in the GRANOLAS’ share prices might be comparatively weak in a V-shaped economic recovery – but companies with their fingers on the global economic pulse, such as mining behemoth BHP, are sceptical about the likelihood of a swift bounce-back.
Nevertheless, investors should take another look at beaten-up value-focused funds, on the grounds that economic growth may still surprise on the upside. Drip-feeding money into funds that focus on fundamental value would be a more sensible approach than piling in, because the disparity in forecasts for corporate profits and economic growth is unprecedented.
Last month’s column highlighted research from US-based asset manager GMO showing that value outperforms growth in a three-stage period after entering a bear market. But that has clearly not been the case so far. Over a year, companies in the MSCI World IMI Growth index have gained 15% compared with a loss of 12% for those in the Value index, when converted to sterling.
Another way of looking at this is the growing dominance of “new economy” companies – such as big tech and those embracing technological change – versus “old economy” stocks such as industrials and extractive industries. Over three years, the disparity in performance is even more marked: growth stocks globally have gained 40% (with the index just a few percentage points below its mid-February high) while value stocks have lost 4%.
Given the uncertain outlook, particularly for value-based strategies, a sensible approach for equity investors who agree with the TINA argument is to have a foot in both camps. This could be achieved by first favouring “quality growth” funds to provide steady gains, then the “reversion to the mean” strategy that value-based funds should eventually capitalise on, plus a lower allocation to the “new economy and future growth” themes, on the grounds that they have already rewarded investors so well over the past decade.
From the perspective of a global equity portfolio, the following Money Observer Rated Funds and a suggested allocation between them could be considered:
This example portfolio provides exposure to developed and emerging markets (where GMO expects the best returns will be made on a seven-year view). Combined, they should be expected to give investors decent “GARP” – or growth at a reasonable price – over the medium term.
Have UK investors seen the elephant in the room?
The FTSE 100 may have recovered nicely since 23 March, but the more domestically focused 250 and Small Cap indices have done even better, gaining 24% to 12 May. The Fledgling index has surpassed that, up 30%.
Some of our Rated Funds have beaten even these impressive numbers. Henderson Smaller Companies IT has gained 48% and BlackRock Smaller Companies IT is up 43%. Eight more of the Rated Funds in the UK Smaller Companies group are beating the FTSE Small Cap index, four of them handsomely.
Although wonderful to see, are investors losing sight of the bigger picture? First, 2020 is forecast to be the worst recession in the UK for three centuries. Second, it is widely recognised in the UK and around the world that the government has badly mishandled its response to the pandemic, being initially complacent and then dangerously inefficient. Floating the idea of quarantine measures from the end of May, for example, looks like a classic case of shutting the stable doors after the horse has bolted.
And then there is the elephant in the room. All the indications currently are that both sides in the EU/UK trade negotiations have dug in. Their entrenched positions mean that it looks increasingly likely that the UK will move to World Trade Organisation trade terms with the EU after 31 December, and the imposition of tariffs on goods and services that this entails.
Call me a cynic, but neither the government’s Covid-19 response and its economic consequences, nor the current impasse in talks with the EU fills me with enthusiasm for UK plc’s prospects in 2021.
The author was editor of Money Observer from 1998 to 2015. * The author invests in these funds and trusts.