Will the market rotation be ultra short-term?

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Technology is maintaining its market dominance – boosting even non-technological companies – while oil companies face increasing challenges over sustainability demands and the threat of inflation is returning to economies. Here is what the team at Walter Scott¹ thinks this all means for equity markets and returns in the months ahead.

Even as value returns to investors’ favour, the team behind Walter Scott’s Long Term Global Equity portfolio (LTGE) maintains high conviction in their chosen holdings. Over the opening months of the year the global market rotation towards value stocks, along with more cyclical parts of the market was to the detriment of what Walter Scott sees as high-quality growth stocks.

Given the strong gains since the market slump of just over a year ago, Walter Scott believe it likely investors will be sensitive to the ebbs and flows of data regarding the pace and extent of economic recovery.

Economic and political uncertainty is a constant these days but the prospects of higher rates and inflation are not concerns Walter Scott managers have had to consider in recent years. Today, both issues are prominent. “The market rotation that began last year reflects higher yields and an expectation of growth and with that, the prospect of inflation. That is an environment that benefits cyclicals and banks and we have noted recent share price moves in those sectors reflect that view of the future.”

Caveat emptor

Overall, from a sector position, LTGE’s position in technology firms was the most supportive over the opening quarter of the year. In particular, the investment team highlighted emerging markets holding Taiwan Semiconductor as a strong performer alongside the US’s Alphabet. Cybersecurity represents an ongoing driver of returns in the tech sector with companies reporting an uptick in revenues in their part of their business or engaging in M&A.

“Another long-term growth vector that remains very much intact is factory automation. The challenges faced last year of keeping production lines running and supply chains intact only strengthened the case for automating.”

Healthcare and industrials lagged over the quarter while limited exposure to strong financials and energy sectors hurt relative returns.

“The financial sector, notably banks, commodity producers and highly leveraged companies were areas the “faster money” focused on in Q1. We are absent from these areas and unapologetically so. Although this has weighed on short-term relative performance, and may continue to do so for a period, it will not persist indefinitely.”

According to the investment team at Walter Scott, with economic prospects brightening, and perceived government backstops in place supporting companies, it is unsurprising heavily indebted companies have seen their share prices rally. “Caveat emptor. It makes little sense to assume that the corporate sector will return en masse to the pre-Covid operating environment. Investing in companies with questionable financial structures on the basis of an improving macro back drop may well prove to be reckless.”

Walter Scott maintains its position to avoid banks, primarily on the back of their opacity, making analysis challenging, according to the group.

When it comes to oil though Walter Scott’s investment team feel slightly different. In the past, the team note, they have been able to find high quality, compelling candidates for investment. There the team say reward for outstanding production growth profiles, global scale and technological leadership was justified. “However, with the added need for a financially credible strategy to transition business models to a more sustainable future, finding long-term growth candidates in this industry has become more challenging.”

Although US stocks held by the portfolio did well in the opening quarter of 2021, they lagged their overall index and as such weighed on relative performance. LTGE’s Japanese holdings were the weakest over the quarter and detracted from relative returns while Europe ex-UK stocks were also weak.

Vaccine influences

The investment team at Walter Scott note that whether or not expectations of global economic recovery this year continues has a lot to do with politics and more specifically, the vaccine roll-out in various regions. “Daily reports on vaccine numbers, across the US and Europe in particular, will continue to come under close scrutiny. In turn, many will be keeping a very close eye on economic data looking for signs of the anticipated flood of pent up demand. The pool of savings needed to fund that demand certainly exists but the extent to which it will be spent, and when, very much remains an open question. It is also very difficult to judge whether this demand will be the beginning of a sustained economic recovery or a more temporary phenomenon.”

Elsewhere, the team at Walter Scott note the flow of company results, alongside their own dialogue with company managements, presents a clearer and more reassuring picture. While Walter Scott agrees the on-going challenges faced by companies should not be underestimated, there has been a reassuringly strong common strand of resilience the investment team is seeing. Using digital means to transform and adapt businesses is one such positive.

BNY Mellon Long-Term Global Equity Fund performance, in euro terms, to 28 February 2021
BNY Mellon Long-Term Global Equity Fund performance, in GBP terms, to 28 February 2021

¹ Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.

Past performance is not a guide to future performance.

The value of investments can fall. Investors may not get back the amount invested.

Objective/Performance Risk: There is no guarantee that the strategy will achieve its objectives.

Currency Risk: This strategy invests in international markets which means it is exposed to changes in currency rates which could affect the value of the strategy.

Geographic Concentration Risk: Where the strategy invests significantly in a single market, this may have a material impact on the value of the strategy.

Emerging Markets Risk: Emerging Markets have additional risks due to less-developed market practices.

GE400386  EXP 21 July 2021

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