The last few weeks of 2020 were characterised by market exuberance and a large appetite for risk, which have carried over into 2021. Markets are awash with liquidity, continuing to fuel excessive risk-taking across equity markets and sectors. The Federal Reserve (the Fed) has injected a staggering $7 trillion into the US economy. Given the size of the US economy, (GDP of around $21 trillion), this represents very substantial support to the world’s largest economy. We’ve also seen stimulus measures in other countries and regions such as China, Japan and Europe.

We are therefore in an environment that favours growth assets. There is a significant tailwind from stimulus; the roll-out of vaccines brings a COVID recovery closer; and record-low interest rates seem set to remain in place as central banks around the world are committed to keeping rates lower for longer. Typically, in this part of the cycle, investors tend to value a very broad exposure to markets when an economic recovery seems on the cards. We also witnessed this after the Global Financial Crisis, and during the height of quantitative easing (QE) stimulus in 2013/14.

When the market becomes convinced that there is money to be made everywhere, the attraction of owning high-quality businesses that have defensive business models may seem less appealing.  But this doesn’t mean we will change our investment strategy. Why?  Because we have seen that these businesses create a very attractive outperformance footprint over time. 

The average business within the Ninety One Global Franchise portfolio delivers a 26% return on invested capital, relative to 16% for the average business in the MSCI ACWI. This means that, on average, our portfolio companies earn a return of 26 cents for every dollar of capital invested. That is much higher (1.6 times) than the average businesses in the index.  

Our quality focus means that we do not always buy market favourites if they do not meet our strict investment criteria.  We typically like companies that have material barriers to entry, the ability to compound growth over time, strong balance sheets and reasonable valuations. We require a high degree of resilience from the companies in which we invest.  Our investment team has successfully managed clients’ money through many different market conditions and economic cycles. We do not get sucked into the market hype of chasing stocks when valuations are stretched. Instead, we stick to our investment philosophy and process, which has enabled us to create long-term wealth for our investors on a consistent basis. 

Tesla, for example, is now one of the top ten stocks in the world in terms of its market capitalisation (market cap), and benchmark index huggers may feel compelled to own the share.  The company has no doubt done an amazing job in launching the electric battery car. While likely to take substantial market share over the next decade, Tesla won’t have the marketplace all to itself.  We believe other vehicle manufacturers will participate strongly in this segment and the market will become quite fragmented. We believe the current market cap of $375 billion is overdone, given the company’s lack of profitability, high debt levels, and questions around volumes and future market share.  Essentially, investors are already paying for a de-carbonised world where the internal combustion engine is extinct and Tesla batteries have a dominant market share. 

Do profits actually matter to followers as long as the share price goes up? 

Tesla in USD

Source: Bloomberg in USD as at 15 January 2021. Daily data over the last five years.

Stimulus-induced reflation trades can be short-lived, if led more by sentiment than fundamentals and not supported by long-term sustainable growth. This has been the case on several occasions historically, and current uncertainty again gives us reason for caution.  Our quality investment approach has a proven ability to outperform over the long term, and the current opportunity remains attractive in both absolute and relative terms. DM/BM