Market Thinking

making sense of the narrative

The 5 C’s. A Great (Portfolio) Reset?

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Global Equities have finally clawed back their total returns relative to Global Bonds and while there is no sign of the theoretical risk free rate approaching the true cost of capital anytime soon, investors accepting nominal inflation are looking at some new nominal assets to reset their portfolios. We think of them as the 5Cs

A focus on Cashflow, China, Convertible Bonds, Crypto Currencies and Commodities.

The 5 Cs of New Era Investing

As a divided US goes into Thanksgiving week feeling more thankless than ever, there are signs appearing of markets positioning for a new era, a New World Order even. However. this is not likely to be the Top Down command and control ideas of the Klaus Schwab and the men of Davos, with their ‘Great Reset’ nor is it the related Green Utopia dreamed of by the ‘progressive left’, but rather it is a slow recognition of an era of expanding government balance sheets and what in previous eras would have been termed ‘reckless’ spending. From a growth point of view this is not necessarily a good thing, unless that spending increases the productivity of the economy. Similarly, from an inflation perspective, too much (government) money chasing too few goods is going to cause higher prices, meaning higher revenues for some but higher costs for others.

We believe that Investors looking into 2021 should be considering a Great Reset of their own portfolios and below we look how some of the signals we are observing come from certain Equity ETFs, may in fact offer a simple way to begin to gain exposure to some of these trends.

One signal of a change of direction might be that picked out in the following chart courtesy of our friends at Redburn, highlighting that after twenty years, the total return on Global Equities has finally exceeded that on Global bonds and raising the question of what role bonds should now play in portfolios.

Chart 1. Global Equity Total Returns finally surpass Bonds

Source Bloomberg. MSCI World Total Return versus Global Aggregate Bonds Total return

We can see how the bond equity rotation moved in two to three year waves post the dot com crash but ultimately in favour of bonds for almost a decade, before turning broadly in favour of equities after the GFC. It had been trading broadly sideways for two years before threatening to break out in favour of equities this time last year and then of course Covid appeared to reset the ratio. Now however, we appear to be back on track.

It’s been a long wait – a little like waiting to break even on the Nikkei – but a reversal is still not as eagerly awaited as the potential for the Value v Momentum trade; not least because it has been so painful to be the wrong side of it. Especially recently. Since the start of the year for example, a Global Momentum factor ETF had outperformed a Global Value factor ETF by 40% (see chart 2). It may well be rolling over and while it is true that there was a similar looking, but ultimately false, breakout back in May, we would point out that when we look at the risk matrix we have for the Model Portfolios we find that, unlike May, our risk score for Value dropped to 1 at the end of last week (making it more attractive). This is the first time since the February sell-off that Value, indeed all five of the factors has been at 1.

Chart 2: Global Momentum versus Global Value – cash flow

Source Bloomberg. Market Thinking.

For us though, the real point is not that the underlying stocks in a ‘value’ factor strategy are somehow ‘cheap’, it is that many if not all of them have a lot of cash flow. Add cash flow is what we need. A diversified Global Value ETF like Blackrock’s IMVL is one possible way to play this.

So, the question is, what else should we perhaps be looking at if risk level is falling and potentially returns are rising in nominal terms? Well a second obvious answer is our second C after Cash Flow, China – especially as it is essentially Chinese demand driving the pick up in industrial activity and China, unlike the west, has a bond yield that approximates a proper cost of capital. Here in Chart 3 is one, relatively simple, way of participating in China A shares, again with ETFs, this time with the A Shares ETF from Blackrock. (Note, these are not specific ETF recommendations, they are more for illustrative purposes).

Chart 3: Diversification and participation in China

Source Bloomberg

The next ‘C” we might consider is the Convertible Bond market. This is a hybrid between debt and equity really as we get a higher yield than bonds, but with equity upside. Moreover, often the exposure can be to the cash flows of growth stocks. For example the Barclays Convertible Bond ETF, shown here (ticker CWB) which is one way of playing convertible bonds has a yield of around 2.2% but a large exposure to Tesla convertible bonds for example.

Chart 4: Convertible Bonds continue to offer exposure to cash flow, often of growth stocks

Source Bloomberg

The next C we might consider is Commodities. While these are, rightly, considered ‘cyclcal’, it looks to us like the demand supply imbalance is moving in their favour at the moment. However, rather than allocate money to a Commodity trading specialist, we think an ‘easier’ way to play these trends may well be to buy equities that are exposed to these cyclical trends. Chart 5 therefore picks out global mining stocks (ex precious metals) with the ticker PICK, doubtless from the old expression that in a Gold rush you want to invest in the guys who make the real money; the ones selling the picks and shovels.

Chart 5. Mining Stocks – Industrial rather than precious metals.

Source Bloomberg

A large driver to this increase in demand we believe is going to come from government spending on infrastructure and housing, which is going to merge with more general demand, especially from emerging Asia and that these will exceed supply – at least for a while. Thus another Commodity to play via companies exposed to the upside is Timber, where we can find another ETF, this time with the ticker WOOD.

Chart 6. Timber another play on Commodity Demand/Supply

Source Bloomberg

And finally, we have the last C, Crypto Currencies. Part of the problem for those worried about Currency debasement through excess visitation to the Magic Money Tree is that all the major currencies (except perhaps China) look to be doing the same thing and currencies are a relative game. We are no experts in the full spectrum of Crypto Currencies, but in keeping with the thread of this post – of how to use Equity ETFs to reposition your portfolio for the New World Order – we would highlight the GreyScale BitCoin ETF (GBTC US) as a way of playing this risk.

Chart 7. Crypto Currencies

Source Bloomberg

To Conclude. The world is shifting to a new expansionist era, but one that is likely to be of lower productivity and higher inflation as governments both intervene in markets and print too much money. There will be winners and losers and we think it worth considering the 5 C’s of Cash Flow, China, Convertibles, Commodities and Crypto Currencies as ways to Reset some of your investment portfolios. We have illustrated simple ways to do this via purchasing ETFs that give exposure to these themes. Note we are not recommending these ETFs for purchase, this is not to be construed as ‘investment advice. Do your own research. However, full disclosure, we do personally own some if not in fact all of these ETFs mentioned ourselves. Cooking, your own you will eat… as Yoda would say.

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