Market Commentary April 2021

Strong US data sees equities higher again

US stocks once again reached record highs in April, as investors continued to react to a combination of improving economic data, increased growth prospects and a successful vaccination roll-out. During the month, emphasis swung back and forth between technology and more cyclical sectors, with the NASDAQ technology-heavy index often moving in the opposite direction from the main market. Continued strength in the oil market also added firm support for energy stocks.

Small caps continue to lead UK recovery

UK Smaller companies had another strong month in April, once again outpacing the mid and large-cap companies in the UK market. This is part of a global rotation towards smaller companies since the vaccine announcements of last November, but is particularly visible in the UK, where large, medium and small cap companies each have their own index. The trend continues to be driven by a number of factors, such as small-caps’ lesser exposure to the strong pound, M&A activity, and the size of the workforce making them more adaptable during times of crisis.

European majors mostly positive

Despite poor GDP numbers from Germany, the EU as a whole performed reasonably well in April, with France leading the gains. This was despite school closures and travel restrictions imposed early in the month to combat the spread of Covid. The Bank of France Governor said on national radio that the country had adapted to work with the virus, and that April activity seemed to be declining less than expected.

Japan stumbles on poor economic data

Household spending fell by 6.6% year-on-year in February: the third successive fall, which saw almost all sectors of the Japanese market weaken. This was followed later in the month by worse than expected earnings announcements. Retail sales, however, grew by 5.2% YoY in March, considerably ahead of the forecast 4.7% rise. Other economic data also surprised on the upside and the Bank of Japan raised its projected growth rate for 2022 from 1.8% to 2.4%. Investors, however, repositioned themselves cautiously ahead of the ‘Golden Week’ holiday of 3-5th May.

 

 

Most western markets provided positive returns in April. Markets continued to focus on the improving data from the US, and more soothing words from the Fed in its April meeting, suggesting that monetary policy will lag improvements in economic data. Similarly, sentiment in Europe continued to improve, despite the ongoing third wave of Covid-19, and the varied response of EU nations. Emerging markets also managed to stage a recovery after a weak month in March, as the weakening dollar provided a tailwind across all the major EM regions.

 

French equities, which started the year with a loss in January, led European markets in April, with the CAC40 now up more than 12% YTD. Economic data and corporate earnings were positive during the month, and continued assurances from the ECB and the Fed helped to support the main markets of the region. A disappointing EU Q1 GDP number of -0.6% was still marginally ahead of the consensus forecast of -0.7%, and hence did not dampen spirits. This fall in GDP saw the EU enter a double-dip recession, with two subsequent quarters of contraction, following the falls in Q1, Q2 and Q4 last year. German GDP contracted by 1.7% over the first quarter, compared with a forecast -1.5%.

 

Sterling was generally weaker in April, and particularly against the euro, as the perceived ‘first mover advantage’ that the UK had gained in the vaccination race began to be eroded. Even strong retail sales data failed to drive the pound higher, amid speculation that the UK recovery was already priced in. Among the major currencies, only the dollar was weaker. After a strong first quarter, the dollar tumbled in April, despite strong sales and employment data, as the markets embraced the Fed’s low-rate policy, and negative real interest rates.

 

Further assurance of low rates from the Fed meant that, whilst US equities were buoyant, Treasury yields edged lower. This was in contrast to most other markets, where investors, looking to participate in the global economic recovery, moved from bonds to equities. It is hard to know whether this is a temporary growth uplift, or a longer-term structural change that will see bond yields continue to go higher. Certainly, in a recovery we would expect to see yield curves steepen, but central banks will react differently, and at different speeds to what is happening in their domestic economies. We have already seen the EU move to dampen yield rises with both rhetoric and intervention, whilst the US has, reiterated its dovish stance, but left its monetary policy unchanged.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

How the Mining sector is digging itself out of a hole

Unloved, under-owned and seen as a negative in terms of ESG, the Mining sector now finds itself in the spotlight.

With the on-going push into ESG investing, many fund managers still have long memories about losing money is previous super-cycles and in terms of outlining an investment process, it’s an easy call to exclude miners for previous bad behaviour and perceptions of poor ESG credentials – most active managers are underweight the sector. You can see just how wary investors are of the world’s biggest miners by looking at how markets are valuing the enormous dividend flows from the sector.

The UK’s ‘big 4’ – Anglo American, BHP, Glencore and Rio Tinto are set to record results this year that should comfortably surpass the profits made during the last commodity bull market a decade ago. They all have stronger balance sheets and much reduced M&A and CapX spend. The only route for that cash is back to shareholders via dividends, special dividends and share buy backs. JPMorgan reckons Rio and BHP are likely to pay the largest dividends in corporate Europe this year at almost $20bn and $18.2bn respectively. With dividend cuts from ‘big Oil’ and the banks, the Miners have stepped up to the plate.

While share prices have risen sharply since the pandemic lows in March, so have commodity prices. However, there has been no re-rating as such for the sector, even though it will have a crucial part to play in the shift to clean energy and the post-Covid economic recovery. At current prices the value of BHP, the world’s biggest mining company, including net debt is just 3.5 times its forecast EBITDA (and those forecasts may prove conservative). That is a huge discount to the multiple of just under 10 times for the MSCI Europe companies. And these are great businesses by most subjective standards, with huge barriers to entry, strong market shares, strong cash generative characteristics and operating margins that vary between strong and obscene, none of which is truly reflected in the ratings. The market is still viewing these companies through the rear view mirror rather than the road ahead.

These companies find themselves in the ultimate sweet spot of restricted supply and both cyclical and structural demand growth.

Let’s look at some of the basics:

• Balance sheets have been repaired, M&A effectively red carded and the same for ambitious new supply projects.
• Over a decade of under-investment has meant that supply growth has been minimal, which has only served to concentrate market share amid the low-cost mega-producers.
• Each commodity has its own additional specifics, such as the issue of ore degradation and increased overburden costs for Copper and the Iron Ore supply land grab several years ago by RIO and BHP which steepened the industry cost curve and added a further deterrent to new supply.
• As a result, supply is extremely tight for many metals and any industry response is several years away.

On the other side of the equation, we are seeing both a cyclical and a structural boost to demand. There is the obvious post lockdown cyclical upswing, boosted by short term and medium term Govt stimuli – Biden’s infrastructure plans being the obvious example. The less obvious and more surprising is the structural shift to clean energy, which will be a huge boost to demand for those unlikely ESG saviours, the big miners.

According to the International Copper Association (ICA), a battery-powered electric vehicle uses 83kg of copper, a hybrid electric vehicle 40kg and an internal combustion engine with only 23kg of copper. When you then factor in the shorter life span of an electric car battery, the implied demand growth for Copper from a global switch to electric vehicles far outstrips the ability of the copper industry to meet that demand. A renewable led electricity supply requires a more robust distribution system, which adds further to the implied supply deficit when faced with the requirements to go carbon neutral. For some of the highly specialist metals, such as Lithium, the demand/supply crunch is even greater.

Given all this it is no surprise to see the likes of Copper and Iron recently hit all-time highs.

And yet the market isn’t buying into this. Mining equities reflect long term commodity price assumptions, and these have not moved up significantly, not yet anyway.

Some caution on the part of investors is understandable. Mining comes with unique environmental, social and governance risks and some investors, scarred by a turn in the commodity cycle in the past, might question the sustainability of current prices.

Then, as now, commodity markets were tight and the world was recovering from the financial crisis. However, that period marked the top of the cycle. The LME metals index, a gauge of major metals trading in London, subsequently fell 50 per cent over the next five years and the market capitalisation of London’s five largest listed miners plunged 75 per cent. But, (and investors hate this phrase,) “it’s different this time”

When commodity markets tanked post 2011, the cycle was already mature, with China’s rapid industrialisation already well established. This cycle is still in its infancy. The global recovery programmes that governments are putting in place today are more commodity intensive than was the case after the financial crisis.

As we said earlier, Miners are also much more disciplined and focused on shareholder returns than they were 10 years ago. Even if they wanted to explore M&A or new projects, there just isn’t enough of either to soak up the prodigious cashflows that are coming their way.

Not only is clean energy driving structural demand growth, but the industry is also in a better place from an ESG perspective. Many have, or are exiting thermal coal, safety protocols have continued to improve, and the majority of the industry have signed up to various climate change initiatives. Just to give one example, the industry has visibility for copper and lithium supplies in terms of ESG best practice, but can Apple say the same about their smart phone suppliers?

Recent months have seen spot commodity prices starting to reflect the extremely tight demand/supply conditions and whilst share prices have started to react, they still imply a very cautious view on assumptions for medium to long term prices for these commodities. Meanwhile, for the big industrial mines, the cash keeps flooding in and the shareholders will be the ultimate beneficiaries.

 

Disclaimer: The information contained in this report is for illustrative purposes only and should not be construed as a solicitation nor offer, nor recommendation to acquire or dispose of any investment. Specifically, the share class used to create the illustrations may not be available on all platforms nor be suitable for individual investors. This report was produced by Collidr Research (“Collidr”) for Affinity Integrated Wealth Management (AIWM) and while AIWM and Collidr use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor Collidr make any representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are subject to change without notice. Model returns are calculated using the most appropriate share class of the underlying funds, having regard to the illustrative nature of the report, with all income being reinvested. As a result, real portfolio performance may vary from model performance. Where model portfolio histories are shorter than three years, historic model returns are substituted prior to inception date with returns from an Collidr performance benchmark. This benchmark is constructed from the average returns of all Collidr portfolios with similar risk profiles that existed during that time. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Affinity Integrated Wealth Management is a trading style of Buryfield Grange Limited, Buryfield Grange Life Planning Limited and Affinity Integrated Wealth Management Ltd. ‘Buryfield Grange Limited’ is authorised and regulated by The Financial Conduct Authority. Not all services provided by Buryfield Grange are regulated by the Financial Conduct Authority. ‘Buryfield Grange Limited’ is registered in England and Wales at Inspire House, 20 Tonbridge Road, Maidstone, Kent, ME16 8RT. Company registration number 4568338. Collidr Research is a trading name of Collidr Technologies Limited, registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and Collidr.

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