True Potential Portfolios Key Themes – July 2021
Investor positioning has evolved with a marginal shift away from the more cyclically focussed areas, namely those more geared into the global economic recovery.
Over the month, bond yields have moved significantly, US 10-Year Treasury yields bottoming out close to 1.2% level in July, intraday touching a low of 1.12%. This was a surprise, there are both technical and fundamental factors that may help to explain some of the move. On the technical side, low issuance was a factor. On the fundamental side, fears of the Delta Covid-19 variant and a rise across the globe in infection rates led to a fall in yields as well as the Fed’s Dot Plot moving from the likelihood of the first hike in 2024 to 2022/23. The True Potential manager cohort believes that the yield for 10yr Treasuries will finish this year around the 1.75% level with forecasts moderating from earlier in the year. Our opinion is that yields will rise from here with current yield levels not fully factoring in economic recovery. As a result, we keep our underweight to bonds within the True Potential Portfolio proposition.
Inflation continues to be a key topic with the most recent UK and US CPI prints surprising on the upside compared to expectations, the US at 5.4% and UK at 2.5% year-on-year growth for June. These higher levels put pressure on central banks to act. In our opinion some components in the CPI calculation that have experienced large increases are transitory, these include used car sales, accounting for a third of the total increase in the US and up 45% year on year. Prices are up significantly due to chip shortages limiting new car production. Companies that can pass on higher input costs are seen as valuable within the Portfolio construct. Wage inflation is evident in certain sectors of the economy, particularly within travel and leisure. Employees are demanding higher wages with a shortage of workers to fill posts. We believe this will improve as more people come back to the working population, particularly as enhanced unemployment benefits end in the US in September.
With economic data so strong there is some evidence/discussion that we are reaching peak global growth with different regions at different points in the recovery cycle. The US has experienced a softening of some data points. The recent ISM Services PMI came in at 60.1, below the previous month’s record high of 64 and expectations of 63.5. Although data is slowing, it is still very much expansionary and that is unlikely to change as different areas within the economy recover at different speeds. Regionally, we are seeing signs of the baton being passed from the US out to Europe and then to other regions, with vaccination rates key to the speed of transition.
Potential catalysts to continuing strength in asset prices as we move through the year include global vaccination rates picking up, vaccines proving resilient against the various strains of Covid-19. Stimulus, both monetary and fiscal, continues to offer support, China recently lowered its reserve requirement by 0.5%. Earnings are predicted to be strong as we move through the next earnings season and as we move into 2022. With valuations in some regions on the high side compared to history, earnings need to deliver.
Looking at specific opportunities, a theme is emerging towards sectors within equity markets offering a high return on capital and strong cash generation. Additions have taken place to healthcare and consumer staples, with other moves being considered. The more cyclical deeper value positions have been moderated as we move away from the early cycle dynamics exhibited in late ’20 and early ’21. This is also evident within credit where moves are taking place to move up the credit quality spectrum with reopening names such as cruise lines offering less opportunity in the current environment.
As we move through the year, opportunities become more nuanced. A more granular approach is being taken. This can be either at a stock or sector level or by looking for specific style tilts. Assets outside of equities and bonds, alternatives, are being added to as ways of sourcing return. The True Potential manager cohort are exceptionally well equipped to offer innovation within this asset class.