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CIO Update: Playing the Long Game

"The two most powerful warriors are patience and time" (Tolstoy).

The rapid rise of the Delta variant is spooking the market. The VIX Index of stock volatility has closed above 20 – seen as an indicator of market stress – on over 40% of days in 2021 and is trending upwards. It also sends a clear message that COVID is not going away anytime soon.  We will have to learn to live with the virus; both its existing and developing variants for some time to come, if not for years.

With the Delta variant wreaking havoc around the globe, the opening-up of economies has slowed, but not halted. There are positive signs that it might be receding, but we should prepare for new mutations with different (milder or worse) characteristics and more or less resistance to the existing vaccines.

Let us look at the last twenty years…

There have been more than enough scandals (Madoff, MDB1, Enron, Worldcom, Lehman, Wirecard), geopolitical tensions (Crimea, Arabian Spring, Venezuela, North Korea, Hong Kong, 9/11) and economic crises (Euro, housing bubble, dotcom) since the turn of the century to cause investors panic and markets to lose trillions of dollars. However, a Euro invested in the global stock market on 1st January 2000, before all the above, would now be worth €2.54 – an okay investment, particularly after starting with a 50% fall in value during the first three years after the dotcom bubble burst[1].

Take-away? Don't lose your patience, the market will find its feet and move forward even if it stumbles now and again.

So, what exactly have stock markets been up to this year? And what can we expect going forward?

Global equities have been characterised by huge relative swings. To mention a couple: The developed market index was 6.5% behind the emerging market equivalent in mid-February, but just shy of 15% ahead by the end July – a swing of over 20% in six months. The difference between value and growth was around 10% in value's favour in May, now, a couple of months' later, it is below 2%.

We can find a plethora of reasons, the most obvious being the Delta variant scaring people away from reopening trades and the crackdown in China on the tech industry. The broader explanation may be that we are at the beginning of transitioning from the (still) accommodative central bank policy of the last decade to a more fiscal driven investment cycle in public infrastructure, renewable energy and new technologies to reduce emissions and capture carbon. With higher uncertainty comes higher volatility.

Economic activity is normalising across the board, albeit at a slightly slower pace due to new strains of the virus, and some sectors still in the early stages of recovery. Fiscal stimulus packages and continued quantitative easing have boosted output and created a tighter jobs market with higher wages and continued inflation. Consumers have saved trillions of dollars since the pandemic started which, combined with higher wages going forward, will continue to boost consumer confidence and spending.

Apart from the obvious need to invest billions of dollars in infrastructure such as roads, schools and 5G networks, the huge amounts needed to tackle the energy transition will support the next technology boom. Just as tech stocks were the stock market darlings of the past decade by boosting productivity, creating social networks and streaming services, energy transition is the new megatrend and last week's alarming IPCC report on climate change will only accelerate its development.

Last June the International Energy Agency (IEA) costed its Sustainable Recovery Plan[2] at $1 trillion annually over the next three years with 70% of investment to be provided by the private sector. This will boost industrial, material and financial stocks as new technologies emerge outside of digital companies.

What about fundamentals?

The graph below shows how the valuation dispersion among S&P 500 stocks has reached record highs, as has the price gap between EM and DM with developing markets currently trading at a 40% discount on a P/B basis[3]. With western populations becoming increasingly protected against COVID, pressure is likely to mount on their governments to share vaccines with poorer countries in the second half, providing EM with a welcome boost. 

This offers active investors attractive entry points in undervalued sectors and geographies that will benefit most from the investment-led economic recovery in the years ahead. Provided we remain vigilant when it comes to variants and reopen in a sensible and equitable way, I am optimistic that we will avoid further lockdowns and see positive economic activity, benefiting companies and their shareholders.

A sustained recovery also means it is unlikely that the reflation trend has stopped, rather it has paused as the Delta variant has surged and will resume. This is potentially good news for value managers like SKAGEN and again emphasises the need to think long-term – for investors like warriors, it pays to be patient.

[1] MSCI All Country World Index in EUR, 31/12/1999 – 10/08/2021
[2] Source: IEA World Economic Outlook Special Report, June 2020
[3] Source: MSCI EM Index factsheet, July 2021

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