170. Is the recent tech sell-off just the beginning of a stock market correction?

27 January 2022 (pre-recorded 20 January 2022)

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[INTRODUCTION]
Sam Slator (SS): I’m Sam Slator from FundCalibre and today I’ve been joined by Darius McDermott and Juliet Schooling Latter to talk about the last quarter of 2021.

[INTERVIEW]
[0:10]

SS: Now, those last few weeks were actually a bit of a mixed bag in terms of performance. We had North America, property, commodities, global equity income, and even UK index linked gilts up as the top performing sectors. As far as I can see, there’s no real pattern there. So why would it be so mixed?

Juliet Schooling Latter (JSL): Well, what we’ve seen with the advent of COVID is that the sort of new paradigm in town. Markets have been obsessed with either COVID beneficiaries or those companies, which do well when restrictions ease. So, for example, tech is the obvious lockdown winner, and travel and leisure, the easing play. So last year, what we saw was this sort of flip flop between these two categories, depending upon whether it looked like restrictions would ease or tighten and the poor stocks, which didn’t fit into either category we’re rather left on the sidelines. So the question is will 2022 be the year we look beyond COVID?

Darius McDermott (DM): The other observation, which I think does hold all those sectors – or at least most of them – in common is inflation. And the longer we got through 2021, the more persistent/stubborn inflation has looked. And that has led to a bit of a cross from sort of growth to value. It began in 2021 in the last couple of weeks. And there’s been quite violent rotation into the early parts of this year, so far, but things like commodity, global equity income, value, UK index linked gilts, you know, already expensive, but getting more so as that inflation looks more stubborn – higher and more stubborn. So you know, there was a lot going on in markets at the end of the year, and the start of this year. That’s certain.

[2:02]

SS: So, as you’ve just mentioned there, we’ve had the tech stocks sold off in the first few weeks of January. Do you think it’s a start for more major correction for markets or for that sector in particular?

DM: So this is the million dollar question at the moment, I have to say. The growth stocks have broadly outperformed for the last decade and broadly massively underperformed so far this year. You know, some of those tech winners that Juliet mentioned, you know, are down by 50%. I’m not sure of the exact numbers, but the likes of Zoom, you know, which was a real tech winner, had a torrid share price time in recent months. So, there’s definitely volatility. The thing we can say, you know, the value stocks have never been cheaper. And if there is then some momentum in that trade, as people go, oh, all my stocks or funds are all growthy. You could see it continuing for a little bit.

But the consensus I read about inflation, is it’s expected to peak in Q1, but probably the end of Q1, ie sort of March time – now that’s economics consensus, I wouldn’t base my whole life around economic consensus, but if that peaking of inflation, that it is going to be sooner rather than later, there may well be that the sort of selling of these tech and other growthy names is approaching sort of overdone. I don’t know, but it’s certainly tricky. And it’s the only story in town at the moment isn’t it?

JSL: Yeah, it’s been quite a vicious sell off we’ve seen actually. So, US inflation for those of you who haven’t seen it sort of hit 7% and the US Federal Reserve’s been sort of rather more hawkish which has, as Darius said, prompted this. And I think it was Goldman Sachs reported sort of value outperforming growth by 24% in just five days. So that’s quite an extreme turnaround really.

DM: Yeah. It has certainly been extreme. And, you know, I think anytime we talked around our outlook for 2022, it was to have a bit more balance in your portfolio. You know, so far it’s certainly been the hype, the winners of the last decade have had a real bad quarter.

[4:25]

SS: Value’s a funny one, isn’t it? Because it had a bounce last year. It’s had a bounce this year, and when it does bounce, it bounces by huge amount. So it’s obviously worth having some in your portfolio, but do you think value’s going to have a better time overall for a longer period? Or is it literally something you have in your portfolio for these moments just to…

DM: I think you have them for these moments. And again, we’ve discussed as a team, there’s a massive disconnect between inflation and government bonds, whether it’s in the UK or US or Europe, inflation is high and rates are low, and it’s never been this different, you know, normally if when rates are high, people spend less because their mortgage payments go up or their debt is, you know, whether that’s individuals or governments I might add. And I don’t think anybody thinks we’re going to have a 5% interest rate anytime soon. So, the banks are, the central banks are starting to react. And it was really the Fed saying, or indicating forward looking indications of four rate rises rather than three, which was the last bit of petrol for this rotation. Personally…

JSL: Although I have to say that that a lot of commentators are actually suspecting that there might be only three rate rises.

DM: Yeah.

JSL: I mean, it’s very difficult to say at this point because a lot of the inflationary factors hopefully will drop out of the numbers. You know, there’s been the issue that we’ve talked about on here before about semiconductors. I mean, semiconductor production for instance, has been boosted massively. So that should be one of the factors that helps to bring down inflation rates with sort of car prices and so forth. Apparently, there are up to 1,700 semiconductors in a new car these days. So that should help things. Energy, I think is obviously another factor. And that’s a difficult one to call. But hopefully, you know, the Fed is saying that they hope that inflation should move closer to their 2% goal by 2023.

[6:42]

SS: And how much of a role do you think the US central bank is going to have on the direction of markets this year? Is it just, is it paramount that they get it right, or…?

DM: Well, I think they’ve already got it wrong. I think they have been slow to move and hence when they’ve gone, I mean, they’ve not taken a U-turn, that would be dramatic, but they, the signaling of three rate rises to four via this genius piece of thing called a dot plot. Please don’t ask me to explain, cause I’m not even going to attempt it, but it’s broadly the regional bankers in the US go plotting this course of interest rates and the market’s taken it quite badly globally, and the UK’s actually bucking the trend at an index level, but equities are of down around 10% and we’re in the, you know, in the middle to end part of January, as Juliet said, you know, some of those rotation between the growth and value, it’s been extreme. So the central bank narrative is having a big effect on markets. And again, when we spoke either on this podcast on the last quarter or any of the outlook pieces we did for this year, we cited central bank is probably the biggest worry, that they’d overdo everything, as is often the case.

JSL: Yeah, they’re notorious for getting things wrong. I mean, I think one of the things that we haven’t mentioned here as well is wage inflation. So that’s something they’re going to be looking at. And one problem is the, is the tight labour market at the moment, you know lots of older people have dropped out of the labour market. People have sort of rethought their working. So with this sort of reduced labour force, you know, employers are fighting for workers and this is obviously causing wage inflation. And there’s also these sort of COVID piggy banks that people in developed markets are sitting on. So when they’re spent, you know, will workers go back? Will that help to reduce wage inflation? There’s just lots of question marks out there I think.

DM: Yeah, I think it’s called the quit indicator in the Americas. A fund manager recently mentioned that the quit indicator is as high as it’s ever been. And that is of course because of baby boomers retiring, but it’s actually people reassessing what type of work they want to do. And definitely in the more manual areas, there is wage inflation and, you know, that’s great for people who are earning more money to deal with the living, the rising costs of the petrol they put in their car. And, you know like our colleague Staci, you know, needs to turn the central heating up.

[9:25]

SS: And we’re just heading into the ISA season now when many investors are thinking about where to put their money, given how uncertain everything is, how choppy markets are, what would you suggest, or where are you personally putting your money?

DM: I think we talked about balance didn’t we? And a lot of clients are full of the high growth stuff. So if you are sitting there with a portfolio of, you know, nine growth funds out of ten, you might want to think about potentially buying something else. But you know, I think because of the real outperformance of growth on value over the last 10 years, it’s naturally, the normal thing is to want to buy funds that are going up, going up more, and that’s been that trade. So not to pick on them, but the likes of Baillie Gifford who are an out and out growth house, for instance, have been very popular with clients and they’ve made, you know, really, really good returns. What you don’t know is what’s going to happen, not just for the rest of this year, but the next five years. And it just seems sensible to me not to have all of my eggs in the one basket.

JSL: Yeah. I mean, I think that investors can hope to see some growth this year, but, you know, the global economy is still growing. And apart from anything else, where else do people put their money? You know, savings rates are not very tempting at the moment, but there are all the concerns we’ve mentioned: inflation, there’s geopolitical risks out there. So again, you know, it’s boring, but being diversified, having a global fund I think is a good idea. And as I said, you know, I’m expecting that there’ll be a reasonable amount of volatility this year. So, investing monthly, which I always mention is quite a good thing. And, you know, having a fund manager who focuses on companies with pricing power in an inflationary environment is no bad thing, but, you know, I always invest for the long term. So, you know, I think that’s what you have to think about is what’s going to win in the long term and try to shut out the sort of short term noise.

DM: Yeah.

JSL: I’ve spent money on the kitchen so there isn’t a lot left to go around, but I like also alternative things like you know Ninety One Global Environment because that’s the decarbonisation theme, which is a long term theme that I like, and they’ve actually been hit by this recent sell-off. Or the left field is biotech, which also looks interesting and has, you know, been sold off recently.

DM: Yeah, biotech, the NASDAQ biotech index underperformed, the S&P by over 20% last year. And, you know, some of the biotech companies and the big pharma companies have got loads and loads of cash on their balance sheet. So we could see a real pick up in M&A, fundamentals look good actually on a PE basis versus its own history. It’s really cheap. And on a sort of like an enterprise or tech or a biotechnology value, they’re still cheap. You know, people trying to work out the value of each company.

And we spoke with somebody earlier today, and as they rightly pointed out it’s biotech companies which have produced a vaccine, or at least, you know, made the vaccine. Moderna is a biotech company and well, nobody had heard of Moderna two years ago, unless you were a biotech investor, but you’ve heard of it now. And the Pfizer vaccine is produced by a German company called BioNTech. So these are both biotech companies and they’ve been you know, hugely influential, but there are other areas, and there’s not many where, you know, they’ve underperformed. China had a very disappointing year last year. Japan didn’t do much. And whereas…

JSL: Yeah Japan, the Japanese market fell from 18 to 14 times sort of over the last year. So that’s looking quite cheap. That might be an interesting area.

DM: And they always say, you know, never bet against the US. And the one thing we know is the US has got 10% cheaper in fairly broad order. And so as Jules says, you know, what else are you going to buy? You, you’re getting nothing minus inflation rate for cash. You’re getting nothing as near as damn it on government bonds minus inflation. So your real return is actually negative. So equities would seem sensible, but do expect a bit of volatility. And, you know, if you put you know, £10,000 into a fund, you’ve got to be able to sleep at night, knowing that it could go to £9,000 or £8,000, but over the next 5, 10, 15 years, you should, should make money out of most of the major equity markets, I would suggest.

But yeah, we both quite like biotech. Sometimes you get recency bias, we saw biotech manager earlier today, but she made a case very, very strong case for the fundamentals and the valuations. And there’s not much out there that looks cheap that you think, yeah, I quite like a bit of that. So there are two funds which we like in that sector Polar Capital Biotech and AXA Framlington Biotech, both very, very good performers and outperform the biotech index over long periods of time.

SS: That’s great. Thank you very much. And if you’d like find out more about these ideas and others, please go to fundcalibre.com and don’t forget to subscribe to the Investing on the podcast.