After numerous lockdowns and false starts in 2020, the widespread rollout of the COVID-19 vaccine has given real hope that economies will soon be able to fully re-open. The International Monetary Fund (IMF) revised its projections of world economic growth in 2021 up to 6%, an increase of 0.5% from its predictions in January. This is the fastest rate of global economic growth since 1980 and is in stark contrast to the reduction in global output of 3.3% in 2020, the worst since the Great Depression. [1]
As in the previous quarter, the change of leadership in Washington was a dominant theme. Once inaugurated, President Biden wasted no time in announcing the American Rescue Plan, a $1.9 trillion stimulus package. This was signed into law in March. Shortly afterwards, the President announced his intention to spend an additional $2 trillion to rejuvenate the USA’s infrastructure via the American Jobs Plan. US equity markets, as to be expected, reacted favourably and the S&P 500 increased by 7.4% over the quarter. With this additional support and increasingly positive outlook for the US economy, the IMF amended its predictions of US economic growth from 5.1% to 6.4% [3] for 2021.
China, together with the USA, are seen to be driving the global recovery. China was the first country to encounter the virus, first to shut down and the first to re-open. The Chinese economy is expected to grow by 8.4% [4] this year despite the continuing trade war with the USA. For another quarter, China again failed to fulfil its commitments to increase imports of US goods, as outlined in the “Phase One” agreement signed back in January 2020. There were hopes that changes in the White House would result in a more cordial relationship between the two nations. However, the first call between President Biden and his Chinese counterpart Xi Jinping in February were reported to be tense. Later in March, angry exchanges between the two nations during high level talks played out in front of the world’s media. As the quarter drew to a close the US reaffirmed its position that it had no immediate plans to lift tariffs introduced but did express a willingness to engage in further trade talks.
The first quarter of 2021 saw a continued resurgence in value stocks, giving further hope to long embattled value investors that the initial upswing in value stocks observed in the last quarter of 2020 was here to stay. Value investing is a strategy whereby investors seek to identify stocks that are currently undervalued by the market. The intention is to buy these “cheap”, value stocks and profit from their eventual increase in price. The opposite strategy is that of growth investing, whereby investors attempt to identify firms whose revenue and earnings will grow faster than the market average.
During 2020, with the assistance of governments and central banks, equity markets rebounded quickly. However, the disparity between the performance of value and growth stocks initially only increased. This was because of the disproportionate impact that lockdowns had on value stocks, which tend to be more cyclical in nature, for example energy, retail, and transport. Growth stocks were more resilient, and some for example, technology stocks, even benefited from the restrictions.
In the last quarter of 2020, investors’ expectations began to change. With the approval of a number of COVID-19 vaccines together with President-elect Biden’s plan to spend trillion of dollars to revive the US economy once in office, the prospect of an economic recovery looked promising. Cyclical stocks looked to benefit more from the developments and hence value stocks began to rise. As 2021 began, the vaccine roll out globally gathered pace and further US stimulus plans were announced, sustaining the value rally.
The reversal of fortunes for value stocks were not the only sector of the market to see a rotation in fortune. Size investors, those looking to invest in small-cap companies, which had also been hit hard by the pandemic, also continued their upwards momentum, which began in the last quarter.
Akin to value stocks, things started to shift in the last quarter of 2020. Small stocks returns are closely linked to the performance of the overall economy. With signs that economic recovery could be fast approaching in the last quarter of 2020, suddenly smaller firms, whose stocks were cheaper, became an attractive proposition for their potential to deliver higher returns in 2021.
A review of the performance of five well known factors strategies over the last ten years reveals the extent of the rotation to size and value in the first quarter of 2021; the losers of previous years, showing the cyclical nature of the value factor. Contrastingly, momentum, quality and low volatility have generated negative returns.
It was not only the US government’s stimulus spending and global inoculation programmes that were impacting equity prices in the first quarter. Early 2021 saw an unusual David-and-Goliath battle over GameStop stock. The most popular explanation of events has been of that of “the populists (a phrase that doesn’t really mean much anymore, beyond just “a collection of guys who are mad”) versus the Institutions” [5] essentially, a young group of stock picking enthusiasts, wanting to test the financial system to make sense of whether it was all smoke and mirrors, set up by large financial intuitions for self-gain, or an efficient capital market engine.
Large investment banks, believing the firm’s stock was all but finished had taken “short” positions, hoping to profit from a fall in its price and eventual demise, common practice in modern day active management, known as short selling. Unfortunately for them, a social media group had formed, unhappy at the “shorting”, believing that the stock had real value in its fundamental business offering. They recruited a mass following of like-minded buyers and using trading apps, drove the price of the stock upwards, causing it to increase from $17.25 to $347.51 during January, an increase in price of 1914.5%. The motivation of the majority of these investors then progressed into punishing hedge funds and testing the financial system as opposed to a genuine belief that the firm was undervalued. However, some investors undoubtedly were able to take advantage of the rapid increase in price and make a quick profit.
The saga continued over the quarter, the stock’s price remained volatile and trading was suspended on various platforms resulting in claims of foul play by investors who saw this as illegal intervention. The US government and regulatory agencies took notice and launched a number on investigations. Where will it end for GameStop? No one really knows, but fundamentally, the company appears hugely overvalued, with social media led investors refusing to sell, claiming it is now not about the profits.
We all like an underdog story but investing is not about trying to turn a short-term profit; that is pure speculation or as some may say, gambling. If you fancy a gamble, then sure, instead of putting your money on “Number 4” at Cheltenham, buy GameStop, but be prepared to lose your entire bet. Unfortunately, despite what you see in the movies, investing correctly is a slow and disciplined process best served by investing in low cost, diversified index funds.
Portfolio Performance [6]
Portfolio returns continue to build on the late momentum of last year. Returns over 1, 3, 5, and 7 years continue to remain in positive territory across all three models. Compared to the last quarterly review, where Portfolio 3’s performance lagged behind both Portfolios 1 and 2 over the 1 and 3-year periods, Portfolio 3, with its higher exposure to equity, now has the strongest performance across all time periods.
OpenMoney Cumulative Gross Performance
Data sourced 28/04/2021. OpenMoney portfolios have been running since April 2017, therefore returns before this date are simulated based on the performance of OpenMoney's underlying investments. Past performance is not an indicator of future returns.
Closing Words
This time last year the world was reeling from the realisation that the virus that had taken hold of our day to day normality and posed a serious global health threat. Governments responded by introducing strict lockdowns and the ensuing panic caused the fasted 30% drawdown of global equities in history.
The team here at Finalytiq will freely admit to being flabbergasted by the market’s reaction. However, our data told us that large market shocks, although rare, had occurred for known reasons in the past and that markets would recover. Indeed, we saw the subsequent fastest and largest advance in equites markets in history during the second quarter of 2020.
A year on and equity markets are above their pre-shock levels. This recovery has been made possible by the tenacity of some very clever scientists to whom we all owe a debt; developing vaccines in months as opposed to years. In the UK at least, we appear to have the virus on the backfoot, and it looks increasingly likely that life may soon return to some kind of normality. However, with France and Germany recently announcing new lockdowns as they struggle to curb a third wave, it reminds us that that the pandemic is far from over.
We wish everyone a safe return to normality and hope the performance of your portfolio during the last year serves to reassure you of the robustness of its construction.
References
[1] International Monetary Fund. (2021). World Economic Outlook.
[2] Global Bonds: Bloomberg Barclays Global Aggregate, UK Gov Bond: Bloomberg Barclays Global Aggregate UK Government Float Adjusted, UK Equities: FTSE All Share, Global Property: FTSE EPRA Nareit Global, Emerging Markets Equity: MSCI Emerging Markets, EU Equities (ex-UK): MSCI Europe ex UK, Japanese Equities: MSCI Japan, US Equities: MSCI USA, Global Value Equities: MSCI World Small Value, Global Equities: FTSE Global All Cap, UK Inflation (RPI): UK Retail Price Index.
[3] International Monetary Fund. (2021). World Economic Outlook.
[4] International Monetary Fund. (2021). World Economic Outlook.
[5] Washington Post. (2021, February 1). A Breakdown of the Gamestop Situation. Retrieved from The Washington Post
[6] All data is up to last price – 5th April 2021. Past performance is no guarantee of future return. Data sourced from Morningstar API. Careful consideration has been taken to ensure that the information is correct but it neither warrants, represents nor guarantees the contents of the information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Percentages may not total 100 due to rounding. Performance Periods: 1 Year: 05/04/2020-05/04/2021; - 3 Year: 05/04/2018-05/04/2021, 5 Year:05/04/2016-05/04/2021, 7 Year: 05/04/2014-05/04/2021. Additional performance periods may be accessed with the help of your adviser via the Betafolio Control Centre
Corum, A. A., Malenko, A., & Malenko, N. (2021, February 18). Corporate Governance in the Presence of Active and Passive Delegated Investment. European Corporate Governance Institute – Finance Working Paper 695/2020.
Rabener, N. (2021). Factor Olympics Q1 2021, Factor Research.
