Ceri Jones considers the fund sectors that will hold up best in the event of a second outbreak.
The Nasdaq – home to tech companies such as Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), Netflix (NASDAQ:NFLX), Spotify (NYSE:SPOT), Facebook (NASDAQ:FB) and Zoom (NASDAQ:ZM) – has surged more than 50% from its 2020 low in March to an all-time high and is trading on a price/earnings multiple of 34. Many tech stocks have been catching the tailwinds of trends that were in place before the pandemic, such as soaring use of cloud services and video conferencing as millions work from home. At Microsoft, for example, chief executive officer Satya Nadella says “two years” of digital transformation took place in two months, with cloud services revenue up 39% in the first quarter, compared with 2019.
Certain tech stocks have now become viewed as safe havens, taking the place of traditional defensive plays such as consumer staples and utilities, and even recently when the markets wobbled on fears of new local lockdowns and travel quarantines, these stocks continued to prosper.
Whether or not there is a second Covid-19 wave, and no matter the shape of the recovery – V, U, L, or K – these businesses should continue to enjoy strong customer demand. If the recovery is V-shaped – a hope many still cling to – then some of the impetus for services such as video conferencing, home delivery and streamed entertainment will fall away, but the pandemic has embedded their use in our everyday lives and these are trends that won’t be rolled back. Like a satnav or dishwasher, tech that makes your life much more pleasant is hard to give up.
The concern is whether these wonder stocks have already got ahead of themselves, but the run-up in prices is a far cry from the tech bubble of 2000, with which it is often compared, when many dot.com companies had no products or services, or even business plans.
However, there are new challenges, such as the cold war between China and the US – tensions that are reflected in Donald Trump’s injunction against ByteDance’s TikTok, the viral video service accused by the White House of jeopardising national security, and his move to ban US residents from doing business with Tencent's (SEHK:700) WeChat app, which erased $34.6 billion (£26 billion) from the internet giant’s market value and could impact its collaborations with US firms such as Electronics Arts and Activision Blizzard (NASDAQ:ATVI). Deutsche Bank argues that the cost of constructing a “tech wall” and developing two sets of standards for operations in the US and China could be $3.5 trillion over the next five years.
Tech and healthcare look well placed
Investors who are not deterred by the rich prices in the tech sector could look at Scottish Mortgage (LSE:SMT), the Baillie Gifford-run investment trust invested in many of the hot tech names. Managers James Anderson and Tom Slater have a strong record, and have more recently invested in Joby Aviation, an unlisted California-based designer of flying taxis, a sector worth an estimated $17 billion by 2040.
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Darius McDermott, managing director of FundCalibre, a fund ratings agency, suggests the Smith & Williamson Artificial Intelligence, which invests in companies that use AI rather than make it, in areas such as voice-activated personal assistants, self-driving features in cars, intelligent disease diagnosis systems, the optimisation of aircraft engine performance and websites suggesting films and songs based on the consumer’s previous choices.
The pandemic also brought out the gold bugs. The precious metal has risen by around a third this year, breaking through its all-time high of $2,000 an ounce in August, as concern escalated. However, a few days later, when markets staged a recovery, it took its biggest one-day hit in seven years, falling 6.6% to $1,865. With price fluctuations depending largely on investor sentiment, the metal could soar again if a second wave of Covid-19 emerges, but it will drop like the heavy stone it is whenever the economy shows signs of an upswing.
The astonishing highs in precious metals and stocks has also been driven by the collapse in real yields, or put another way, interest rates are so unattractive once you take inflation into account that investors have flocked to every type of investment other than cash. Real yields in the UK and the eurozone are sub-zero, and the yield on 10-year inflation-linked US government bonds is below -1%, a historic low. Central banks will continue to do whatever is required to keep real yields low until a recovery is entrenched, suggesting that the worst is probably behind us.
Healthcare stocks also performed well during the pandemic. Some of this was the search for a Covid-19 vaccine; with no fewer than 170 large and small participants in the race, this was always going to be a throw of the die. However, people will forever be more health-conscious and long-term factors such as improving global prosperity and scientific advances should support this burgeoning sector – including healthcare premises REITs, such as Primary Health Properties (LSE:PHP).
Drug pricing in the US will remain politically controversial, especially as the presidential election looms. According to a 2019 Organisation for Economic Cooperation and Development (OECD) report, the US spends roughly $1,162 on pharmaceuticals per head, twice the average spent by other member countries such as the UK, which forked out £398 ($497) per capita.
President Trump, a fierce critic of drug prices, signed four executive orders aimed at cutting prescription drug prices in July, to allow discounts and the import of cheaper drugs from abroad. That’s worrying, but healthcare is a much broader arena than pharma alone, and prescription drugs account for just 13% of US healthcare spending, with only half of those patent-protected.
Diversify beyond the UK
While tech has shone all year, the UK equity income sector has been one of the worst performers. Plummeting oil prices were initially caused by the price war between Saudi Arabia and Russia, and exacerbated by falling demand during the lockdown, so that in April West Texas Intermediate (WTI) turned negative for the first time in history. This hit the UK’s oil majors, which are often a top holding in UK equity income funds.
Royal Dutch Shell (LSE:RDSB) and BP (LSE:BP.) both cut their dividends and face a harsh operating environment with continued uncertainty in oil demand, as travel diminishes and the work-from-home trend persists. Long term too, crude oil demand will gradually fall as consumers are incentivised by their governments to switch to electric vehicles.
Savvy investors will diversify beyond the UK, which has handled the Covid crisis particularly badly. “While Covid is not completely under control, for most countries it is no longer the overwhelming event that it was back in March and April,” says Ayesha Akbar, a multi-asset fund manager at Fidelity.
Akbar adds: “Governments have learned how to better deal with outbreaks and it is unlikely that we will have national lockdowns again, although this does mean that economic activity might also plateau. Monetary and fiscal policy continues to support markets, and this may be further buoyed by emerging news on vaccine trials, but this is unlikely to be a magic bullet.
“It could, however, help bolster optimism and get the tourism and hospitality sectors moving again. Tempering my optimism are the plentiful risks on the horizon: the potential for a severe second wave of the virus, ongoing US/China tensions, the US elections, and a lack of fiscal support. Consequently, I don’t want to take too much risk, and I am employing hedges for any uptick in volatility.”
Akbar suggests buying equities, especially on the dips, and favours the Rathbone Global Opportunities, which has holdings in some big tech stocks such as Amazon (NASDAQ:AMZN), Tencent (SEHK:700), Ocado (LSE:OCDO) and PayPal (NASDAQ:PYPL), but also some “under the radar” companies with the potential to grow.
Further out, the economic cycle will eventually turn and traditional cyclical sectors such as banks will benefit. Goldman Sachs expects the S&P 500 to jump 11 % to 3,700 if a Covid-19 vaccine can be found but warns that a successful vaccination might backfire on tech stocks, while driving up unloved value stocks, in a long-awaited rotation from growth to value.
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“Parts of the market where businesses appear stagnant have been well and truly left behind in the market recovery we have seen,” says Jonathan Miller, director of manager research ratings at Morningstar.
Miller adds for investors looking for something different, away from the quality growth areas that have shined for around a decade, Jupiter UK Special Situations could fit the bill for investors looking for a value-biased UK equity strategy.
“It has been run by Ben Whitmore since 2006, who tries to identify companies with strong balance sheets and prominent franchises. The largest sector exposure is to financials where Aviva (LSE:AV.) and Standard Chartered (LSE:STAN) feature. Further out-of-favour plays include mining company Anglo American (LSE:AAL), WPP (LSE:WPP) in the advertising world and BP,” says Miller.
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