Deep Dive into global equities: Ready for a K-shaped recovery?
New series exploring one asset class each week
In a brand new series replacing Bull Bears, Investment Week takes a deep dive into one particular asset class each week. Four commentators – one specialist fund manager, one multi-asset manager, one fund-picker and one CIO or economist – will each provide their in-depth takes on the market area, including the biggest potential risks, long-term themes and where they are seeing investment opportunities.
This week, four experts give their thoughts on global equities, starting with Apple recently breaking the $2trn mark.
Vafa Ahmadi, head of global thematic equities at CPR Asset Management
Since March lows, equity markets have risen like a phoenix from the ashes. While the real world lags behind, the magical realm of equity markets see stocks levitating back to pre-crisis levels.
Buoyed by ultra-low interest rates, quantitative easing (QE) and the paranoia surrounding another financial collapse, equity markets have pulled off one of their most impressive conjurings to date: the 'V'-shaped recovery.
But, as with any good magic trick, all is not as it first seems. Look a bit closer and the 'V'-shaped line traced across the face of global equity markets actually resembles a K.
Yes, that is right, we are in the middle of a 'K'-shaped recovery.
As the name suggests, we are seeing a small handful of winners account for nearly all of the growth in the market, while a host of laggards continue to get bogged down.
To put this in perspective, this year, the five largest constituents of the S&P 500 - Apple, Amazon, Microsoft, Facebook and Alphabet - have seen their shares jump by 22% or more. By contrast, the median stock performance across the S&P 500 year-to-date is a 4% drop.
The question we must now ask ourselves is: with such divergence in the market, where does one look to buy? Do you enter at the top and hope that the winners continue their streak? Or do you buy in at the bottom and hope that downside is now mostly behind us?
To put it another way: how do you play the 'K'?
Playing the top
Sitting at the top of the 'K' is the tech sector, up around 10% on pre-crisis levels. Some of the recent movements in this sector are nothing short of unbelievable.
Amazon's stock is up 86% year-to-date, Tesla recently surpassed Toyota to become the world's most valuable car company and, just last week, Apple became the first US company to hit a market cap of $2trn, doubling its valuation in just over two years.
Impressive though this might be, for investors, there is a problem. This is the same problem tech investors have faced for the past ten years. Tech is new. Tech is exciting. And this only means one thing: Tech is expensive.
While it is difficult to deny the quality of these business and the innovation they continue to deliver, it is also difficult to ignore the wildly inflated price tags.
So mind-boggling are the valuations that even Elon Musk felt the uncharacteristic need to restore a sense of sanity, tweeting that "Tesla stock price is too high imo", sending the stock down 10.3% as a result.
For investors looking to buy into the strong, long-term trends at the core of tech's outperformance while avoiding the hype-driven price inflation and volatility, what are the alternatives?
Look below the surface of mega-cap tech stocks, and you will find high quality, profitable companies in the mid- and large-cap range with often overlooked potential.
This potential lies in the fact all industries are becoming increasingly reliant on new technology to conduct business, positioning the suppliers of this tech on especially high ground.
By selling across industry horizontals, these companies are systemically sucking the growth out of the rest of the market.
At the same time, these companies - dealing in anything from semiconductors to advanced data analytics - are not as eye-catching and exciting as the mega-cap FAANG stocks, making them less prone to hype and overvaluation.
Playing the bottom
Playing the bottom of the 'K' presents its own set of challenges. The companies and sectors that have been hardest hit by the crisis continue to face long-term uncertainty as new trends look set to permanently disrupt the market.
If everyone continues to work from home after the Covid-19 pandemic subsides, for instance, what will happen to commercial real estate or commuter transportation, or high street coffee shops?
While this uncertainty can make it difficult to identify entry points at the bottom end of the market, on closer inspection, buying opportunities can be found.
Take energy. The energy sector has been the hardest hit by the crisis, down over 30% since mid-February. Saudi Arabia, the world's top oil exporter, saw crude exports drop to their lowest on record in June, and global energy consumption and prices have tumbled.
For energy investors one area to look at is renewables. The crisis has accelerated existing trends driving the uptake of renewables and, while renewable companies have been hit by falling consumption and power prices, the secular transition to clean energy makes them an attractive bet.
There is, however, a more nuanced way of leveraging this trend. Instead of buying directly into companies that have already completed the transition to renewable energy - a more obvious bet to make - consider buying into the companies that are part-way through.
A clear and effective transition strategy might be just as impactful - both in terms of profitability and sustainability - over the long term.
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