True Potential Portfolios Key Themes – April 2021
Chris Leyland, True Potential Director Of Investment Strategy, looks back on the key themes around the True Potential Portfolios over the past month
The reopening of the global economy and cyclical recovery remain a core belief. Factors supporting this include continued vaccine rollout, further stimulus through Biden’s US infrastructure plan, exceptional economic data such as record high US ISM services data at 63.7 and the continuing fall in unemployment, the US unemployment rate is now 6.0%, compared to the 14.8% peak last year with estimates point to a year end figure of 4.5%. The Fed has guided interest rates to stay close to zero until 2024 with US GDP growth for this year predicted to be 6.5%. We believe that cyclical assets will perform well in this environment. Over the month, transactions within the True Potential Portfolios have tilted further towards this investment thesis, although we still retain our long-term central tenet of diversification by investment and manager style.
Since the start of March, value as an equity style has outperformed growth by just under 1%, although as we move through the month, growth as a style is gaining some ground. US 10 year Treasury yields have risen from 1.45% at the start of March to 1.57% as I write this having peaked out at 1.75%. Having trebled from their lows a year ago, 10yr Treasury yield changes from here are likely to be gradual. Directionally, however, US 10yr yields are still headed higher with 1.75% to 2% forecast for the year end. Implied volatility within the bond market, measured by the MOVE Index, has eased from a peak of 72 in March to current level of 60. Although sovereign yields have risen, absolute yield levels continue to be unattractive relative to the yields available within credit. From a multi-asset portfolio perspective, total exposure has been tapered by managers in recent months, however, the diversification properties of holding exposure to nominal bonds remains.
Recent inflation prints have surprised to the upside in the US with both Producer Prices and Consumer Prices coming in ahead of expectations. We know there will be an inflationary impulse when compared to 2020, this has started to come through, particularly in respect of energy prices. We believe that inflation will be contained and do not see an environment of significantly higher inflation over the longer term. Powell has continued with his guidance that the Fed are unlikely to intervene and they are not looking to raise rates until growth and employment improvement are evident and sustained. All of the above factors lead TPP to be positioned moderately underweight fixed income to reduce interest rate risk.
Risks do exist to the above thesis. The tightening of financial conditions, particularly with China continuing its policy of normalisation/stabilisation, is a risk if enacted too quickly, but we believe that the Chinese government will be careful in moderating debt levels. The market also has awareness of the plan, documented within the Three Red Lines policy, however, the headwind presented to fixed asset investment is unlikely to be contained within domestic borders. Looking over the year, we see financial conditions continuing to remain loose globally. Vaccine rollout is uneven with some regions, particularly emerging markets, struggling to deal with Covid. Although over the short term this is uncomfortable, over the longer term we expect this to even out.
Since our last meeting, discussions on emerging markets compared to developed markets within the equity space have continued. EM has lagged DM this year hindered by slow vaccine rollout, a strengthening USD and China’s natural slowing from the pace of recovery that was seen last year. Within the proposition we express our preference for developed markets with emerging markets presenting an opportunity at a later point in the recovery cycle.
Views on the USD have not changed, the USD will encounter structural headwinds; growing twin deficits, perceptions that it is an over-valued currency, and less attractive in a broader growth environment with the potential for real yield convergence as the cycle develops. The timing aspect for this weakness in the $ to unfold is impossible to predict accurately. Near term relative strength of the US economy could lead to strength in the USD and we note a bullish US Dollar tactical trade enacted by one of our managers.
The recent announcement of the potential tax increases for US corporations is not seen as a major risk. The taxation policy is not a one-off hit to earnings but will be termed out over a period of years and still very early days with no agreement. We believe there will be much discussion and alteration of the proposed bill ahead of any formal agreement. However, if implemented there will be a disproportionate impact on certain businesses that have very low tax rates.
We are seeing further evidence of portfolio innovation by our managers as the recovery in cyclicality advances from early stages. This includes innovation within all asset classes, including a sector neutral value equity product, small cap value, and further work within alternative investments.