Market Outlook February: Return to uncertainty

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There were reasons for optimism at the end of last year. We could sense the beginning of the end of the pandemic. The current scenario is less encouraging. New coronavirus variants keep popping up, causing new lockdowns. The last part of January also brought more turbulence to the securities market, with some individual equities fluctuating wildly. These factors give reason to be more cautious when it comes to risky assets. We still maintain that we’re edging towards normality, as more and more people get vaccinated. The US political landscape has also become less unsettled. This makes it easier for the authorities to take steps to counteract the decline in private demand. We therefore choose to maintain a neutral weight in equities in our portfolios. We are keeping cyclical sectors in the equity portfolio in an overweight position.

The interest rate scenario will be crucial
Are low interest rates good or bad for equities? The classic answer, and probably the correct one, is: that depends.

Low interest rates are good because the current value of future cash flows increases. As an economist would say, the present value increases. But low interest rates are also a sign that the future may not look too bright. There will be more uncertainty relating to future cash flows. There can be no doubt that the central banks are being active and creative. Their measures are powerful. We maintain, however, that 2020 is not the new normal. We will return to more normality and the central banks will in due course be able to ease off, but there are no signs of that happening this year. Short interest rates will remain unchanged, but longer global rates will rise in this scenario. But that won’t happen until the uncertainty brought on by the pandemic subsides. When the vaccine rollout has progressed further and we start to see a decline in mortality rates and hospitalisations, long-term global interest rates will become less attractive. If our assumption proves true, we also know which equity sectors will perform best. We only have to look at what happened at the start of January this year, when long-term interest rates rose. Back then, the cyclical sectors finance, materials and industrials performed best. The weakest performances came in the more defensive sectors like stable consumption and real estate. Since we believe that long-term interest rates will rise, we have chosen an overweight position in cyclical or cyclical-sensitive equity sectors.

Another point we would like to emphasise is that politicians are increasingly willing to spend money. The financial crisis taught us a new word: austerity. That is to say, the authorities were eager to cut spending after the financial crisis. Austerity is not a topic we hear about from leading politicians and academic communities now.

Healthcare sector up to neutral
Even though we are overweighting cyclical sectors, we are fully aware of the many clouds on the horizon. We’re therefore taking the healthcare sector up to neutral weight. This sector is interesting for at least three reasons:

i) Earnings are far more stable in the healthcare sector than in other sectors Healthcare sector earnings fluctuate less. The demand for healthcare services and medicines is not affected by economic conditions.

ii) Despite healthy earnings in this sector, returns have not outperformed the market of late. In other words, the price-to-earnings ratio in this sector has improved.

iii) The healthcare sector has a clear overweight in US companies, and consequently US dollars. This share is around 70 per cent. Having US dollars in a portfolio is very useful. When there is unrest in the stock market, the dollar often becomes stronger and this compensates for fluctuations.

Technology down to underweight
We have bumped the healthcare sector up to neutral, and financed this for the most part by selling technology sector equities. For quite some time now, the technology sector has benefited from structural factors. Digitalisation, the ‘internet of things’ and large IT investments in private as well as public entities, have contributed to this. The sector has slowly enroached on other sectors. This will continue. The sector enjoyed additional tailwinds throughout 2020. Working from home, online meetings and increased social distancing are keywords here. This made the sector a clear winner last year. Will it be a winner again this year? The structural factors may point in that direction, but we think the tailwinds from the pandemic will subside. They certainly will if interest rates begin to rise. If that happens, other sectors will become more interesting. We should also keep in mind that the pricing of several leading technology companies is high. This pricing is vulnerable if expectations are not met.

High-yield bonds
Nordic high-yield bonds suffered a serious setback last winter, falling by around 23 per cent. Looking at 2020 as a whole, the return was negative, In other words, this market did not recover as quickly as the stock market. Running yield therefore remains relatively high. It’s now around 6.7 per cent. However, we are unlikely to end up with 6.7 per cent. A certain amount of loss will occur. With normal losses, however, the risk/reward is satisfactory compared to traditional bond markets.