Market Update: June 2021

Jun 10, 2021 | Articles, Global Markets Update

For Accredited Investors Only as defined in the Monetary Authority of Singapore Securities and Futures Act (Cap. 289) and its subsidiary legislation. For Professional Investors Only as defined in the Securities and Futures Ordinance (Cap 571, Laws of Hong Kong) and its subsidiary legislation. This advertisement has not been reviewed by the Monetary Authority of Singapore.

Playing the Long Game

Since the beginning of the year, we have been mildly cautious in our commentary. The equity market appeared to be getting ahead of itself with rapid economic recovery widely anticipated. While the economy has been largely robust, the real economy is a little like the equity market, there are mini-cycles within the larger cycles. With strong economic data in Q1 2021, particularly in the US, it was not a surprise to see some cooling for April and May data. This may persist for a few months before the economy again gathers steam. There is likely to be too much easy money floating around for spending to simply stagnate for a protracted period.

Apart from the various stimulus programs around the world, we have also mentioned previously about the USD2+tn of additional savings in the US since the start of the COVID. However, these pale in comparison to the wealth created by the stock market. The MSCI World Index has gained 23% since the pre-COVID peak. That’s USD10.7tn of wealth creation, equating to 13% of world GDP. This wealth would have far greater impact if it was evenly spread, nevertheless, it should still greatly boost consumer spending power. The gains of the relatively wealthy may also pressure the redistribution of wealth as we are seeing with President Biden’s capital gains tax proposals that would ultimately benefit more broad-based spending.

The other factor is economic re-opening. With governments in Singapore, Hong Kong, and Australia clamping down on travel and social distancing restrictions in recent weeks, it may be easy to lose sight that the largest centres of COVID infections have witnessed dramatic falls in infection rates. US new cases are now below 10,000 per day. Just five months ago they were peaking at over 300,000 per day. That’s a 97% drop in numbers. Already, more than half of adult Americans are fully vaccinated and 62% have had at least one shot. In India, the infection rate remains high and the efficacy of detection remains debatable, however, reported new cases are now less than a quarter of where they were at the beginning of May. Some variant of COVID is likely to be around for years, but as the world steadily becomes vaccinated, it is likely to be a case where we learn to live with virus rather than the current stop-start to full reopening.

Source: BBC News

If It’s Not Broken…

In recent years Growth stocks have clearly outperformed Value stocks. Indeed, from April 2020 to the end of 2020 (post-COVID sell-off), the MSCI World Growth Total Return Index outperformed MSCI Value by 22%. However, YTD to the end of May, Value is up 17% and has outperformed Growth by 10%. With the prospect of continued economic re-opening and the potential for regulatory headwinds for certain mega tech stocks we expect a diversified portfolio may continue to outperform a growth portfolio over the Northern summer. For example, recent discussions between the G7 on a 15% Global corporate tax rate could provide a headwind for mega tech stocks such as Google, Apple, and Facebook to name just a few until the issue is finally resolved. Considering the complexity of the issue, this may drag on for some time. In the meantime, these companies have a structural and operating tailwind so price performance will likely hinge on which contains the greater surprise factor.

The clear outperformance of Growth over Value is a relatively recent phenomenon. Even during the Dotcom boom, Growth did not really stand out in terms of performance until 1999, the final year of the bubble. During the 2003-2007 bull market, the MSCI World Value Total Return Index outperformed the Growth Index by 9%. In fact, after both the 2001/2002 recession and the 2008 GFC, Value clearly outperformed Growth in the year following the market trough. The difference during COVID was the government-imposed restrictions on travel and social distancing which favoured products and services that enabled online access. It appears as though equity investor views are now also “normalising”.

The clear outperformance of Growth over Value started to occur at the beginning of 2017. One could argue about the reason behind the performance. Was it the flattening of the US yield curve as the short end rose that occurred at almost the same as the start of the outperformance of Growth? Market theory and strategists may suggest this was the cause and they are probably at least partly correct, but I prefer a more mundane business reason such as demand for tech products beginning to accelerate. Tech companies have been the big driver of Growth Indices. Google used to provide search query statistics and we could have used that as a proxy for the growth of online products and services but they stopped providing that information in 2013. However, we can still use Google’s/Alphabet’s revenues as a guide. By 2017, Google was already reporting USD110bn in annual revenue, hence percentage growth may not provide an accurate gauge of industry growth, but when we look at absolute growth we can see there is indeed a jump from 2015 to 2018. There is a tripling in revenue growth in absolute terms. Facebook’s revenues show a similar acceleration in absolute dollars over this period. This indicates a large step-up in the amount of money being spent for online services.

Source: Statista.com

In 2020, certain tech companies like Zoom specifically benefitted from COVID and had massive growth rates from a low level, however, it was not yet obvious that this would be followed by a structural surge in spending on tech companies. This required the mega-caps to show an acceleration in growth. Google’s revenue growth both percentage change and absolute terms had been falling since 2018, but in Q1 2021, revenue growth was a huge 34%, or USD14bn in just one quarter. This is the largest percentage change for a quarter on a y-o-y basis since Q4 2012 and the largest gain in dollar terms for the company ever. It indicates that spending on technology services (in this case advertising) was coming back and notably far stronger than it was previously. This is supported by robust results from Facebook, Snap, and others that largely depended on advertising.

The percentage growth rates appear unsustainable for the mega-caps, and indeed, consensus forecasts for subsequent quarters are more subdued, but as to the question as to whether there has been another acceleration in revenue spent on the sector to justify a large increase in tech share prices, the answer is “yes”. Whether the quantum of the share price increases is justified is a more difficult question, and because it appears more difficult, the market may take some time to digest this conundrum which, together with the regulatory uncertainty, could see tech stocks, and hence Growth Indices, range-bound in the interim.

Investment Recommendations

Progress on Laggards

In recent months we have been tilting recommendations towards laggard stocks, those that are currently out of favour. Because of this, sometimes investors need to be patient. Other times, the wait may be a short one as we have seen with Eli Lilly (LLY), a name we suggested last month. If you recall, mixed results on their drug for Alzheimer’s saw the stock drop significantly. Nevertheless, we mentioned that the drug, based on data to date, appeared to be as effective, if not superior, to Biogen’s Aduhelm. Well, Aduhelm, somewhat unexpectedly, received FDA approval on June 4 and the stock rocketed as much as 50% before settling 40% higher. LLY, having a 5x larger market cap, settled 9% higher on the news. Overall, it’s been a 12% pop since our recommendation which is a nice little win on a mega-cap in an uninspired market. Among other “event-driven” trades we also highlighted the Cruise-liners two months ago. Royal Caribbean is expected to resume US cruises on June 26th. This stock and Norwegian Cruise Lines, which are expected to start US cruises in July, are up a little from our recommendation but have yet to break out of the trading range that a sentiment change would likely precipitate.

US Transport – a Mix of Tailwind and Recovery Potential

This sector is intriguing. There is a mixed bag of firms that i) benefitted from COVID such as UPS, logistics company Expeditors International, and road transporter JB Hunt, ii) some that were mildly negatively impacted such as FedEx and rail transport, and iii) others where operations were decimated such as the airlines. The latter is one of the few subsectors where share prices remain significantly below pre-COVID levels. Even the major US hotel chains are trading above pre-COVID levels despite 60-65% occupancy rates. Meanwhile, airline bookings for the week of June 4-10 are 83% as high as those taken over the same period in 2019. American Airlines recently mentioned that their load factor in May was 84% and that they were seeing yields at or above 90%. We don’t want to make too much of a continuing difficult time for airlines but obviously, the trends are currently improving.

There are two liquid ETFs that cover the US transport sector, IYT, and XTN. Both have their unique features, particularly XTN which is equal-weighted with 41 positions whereas IYT is concentrated with only 20 positions. Curiously, despite their differences, their performances have been similar for the last 5 years.

Transport ETF Subsector Exposure

Chart: Performance of Transport ETFs and JETS US (predominantly US airlines ETF) 

Source: Bloomberg

Logical to Like Logistics

There are also 2 stocks we like in the Transport sector. One is FedEx (FDX) that we have highlighted in February’s Insight after the stock price slipped despite a robust operating performance. The company is expected to announce Q4 earnings on June 24 (May YE). The other is a stock called XPO Logistics (XPO) which is benefitting from the secular tailwinds from growth in e-commerce. It has a diversified business with approximately 60% in transportation and 40% in logistics. The geographic split between the US and European exposure is similarly 60:40. Revenue has grown from just USD7.6bn in 2015 when the company was still loss-making to a consensus USD19.3bn in revenue and USD676mn in estimated profit for 2021. Since 2015 YE the share price has risen by 440%. In December 2020 the company also announced that it intends to spin-off the logistics business in H2 2021 that may result in a positive re-rating of the combined business.

When speaking of logistics, it’s difficult not to mention, Prologis (PLD), a REIT that focuses on logistics facilities and is the largest industrial real estate company in the world. A combination of robust growth prospects, high occupancy (95%), and strong pricing is likely to produce compelling NAV and cash flow growth over the medium and long term. PLD estimates that e-commerce consumes 3x more space than brick and mortar retailers because transport costs account for 50% of supply chain spend, which places pressure on the need for warehouses near population centres. While there is a risk that the stock is already well-discovered and well-held, the fundamentals provide a strong case for ownership. A smaller logistics REIT that has a domestic US focus is Duke Realty (DRE). It is only one-fifth the market cap of PLD. Both provide an expected dividend yield of circa 2% for 2021. Back in March we noted the strong recovery of REITs as an asset class and postulated there still may be further upside.

Odyssey Model Portfolio Performance

Note: Due to a technical issue, we are not able to provide returns for the securities in the Model portfolio for this month. 

If you like to receive more information on our portfolio solutions, please contact us here: info@odyssey-grp.com.

Japan 2023 Tourism Recovery Will Be Determined By Inoculation Rate

May 26, 2021 | Articles, Global Markets Update

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2023 Tourism Recovery Will Be Determined By Inoculation Rate

星野佳路　星野リゾート代表

新型コロナウイルス禍で観光旅行関連の消費はブレーキがかかった状態が続く。いつ、どのように回復するのか。必要な政策は何か。星野リゾート代表、星野佳路氏に聞いた。

――旅行・宿泊の需要をどう見ていますか。

「年4.8兆円あったインバウンドは蒸発したが、旅先を海外から国内に変えた日本人の需要3兆円が補っている。日々の予約は感染者が増えれば落ち、感染者が減れば持ち直す。足元は感染状況が悪化しても昨年ほど予約は落ちない。ワクチン登場が大きい。感染が落ち着けばGoToトラベルも再開するだろう」

「今後はワクチン接種のスピードにかかっている。ワクチン接種が進んだ米国や英国では行動制限解除を見越して旅行予約が回復している。日本でも接種が進めば上向くだろう。需要は2023年にはコロナ前の水準に戻るとみている」

――インバウンドは。

「東京オリンピック・パラリンピックをたとえ無観客でも安全に開催できれば意義は大きい。活躍する選手の姿、開催地の街の様子がテレビ中継で世界に伝わり、次は日本に旅行したいと思う人も増えるだろう」

「どの国も相手国の感染状況やワクチン接種の進捗を見ながら人の往来を元に戻していくプロセスが22年に本格化する。インバウンドは台湾、オーストラリア、中国、アメリカと徐々に戻ってくるのではないか」

――コロナ前に戻りますか。

「オンライン会議の定着で出張は減るかもしれないが、観光は成長軌道に戻る。マレーシア、インドネシア、中国などで増える中間層はコロナ禍が終息すれば海外観光旅行に動き出す」

「国内は変わる兆しがある。日本の観光産業の生産性が低いのは需要が休日に集中していたからだ。需要の波に対応するため雇用も75%が非正規だ。だがコロナ対策でテレワークやワーケーションが普及し、平日需要が増える可能性が出てきた。コロナ後も定着すれば地方の経済・雇用にとってプラスだ」

――必要な政策対応は。

「GoToトラベルの35%の補助率は下げるべきだ。コロナ終息で事業が終わる時に大幅値上げとなり反動減が大きくなる。補助対象はワクチン接種者としてワクチン接種を促進することも提案したい」

「何よりワクチン接種を早く進めて重症者を減らすことが重要。夏に経済が回復するには今後1カ月が勝負どころだ。先行するイスラエルや米欧各国は接種者の行動制限を緩めるインセンティブがある。政策を組み合わせて一気に接種率を上げるべきだ」

――星野リゾートはどう取り組みますか。

「需要が冷えた都市部でホテル運営を投資家から任される案件が増えている。供給過剰の市場で経営を立て直すのはバブル崩壊後に経験を積んでいる」

「ホテル運営企業として世界で認められるため北米には進出したい。日本の付加価値を提供できる温泉旅館をやる。80年代に米国でホテルを買収した日本企業が失敗したのは西洋ホテルをまねたからだと思う」

（聞き手は編集委員　吉田ありさ）

ほしの・よしはる　米コーネル大ホテル経営大学院を修了後、91年に家業の4代目代表に。60歳

Yoshiharu Hoshino, Representative of Hoshino Resorts

Sight seeing travel-related consumption will continue to slow down due to the new coronavirus disease. When and how will you recover? What is the required policy? We asked Mr. Yoshiharu Hoshino, the representative of Hoshino Resorts.

――How do you see the demand for travel and accommodation?

“Inbound, which was 4.8 trillion yen a year, is eliminated but the demand of 3 trillion yen for Japanese who have changed their travel destination from overseas to domestic is supplemented.

Daily reservations will drop if there is an increase in infection, and will recover if the number of infected people decreases. Even if the infection situation worsens, reservations will not drop as much as last year. Vaccines are coming out. If the situation in Japan recovers, we believe Go To Travel will resume. “

“From now on, it depends on the speed of vaccination. In the United States and the United Kingdom, where vaccination has progressed, travel reservations are recovering in anticipation of lifting restrictions on behavior. In Japan, if vaccination progresses, demand will increase in 2023 and is expected to return to pre-corona levels. “

–What about inbound?

“It would be significant if the Tokyo Olympics and Paralympics could be held safely even without spectators. The appearance of active athletes and the state of the venue city will be broadcast to the world on TV, and more people will want to travel to Japan next time.”

――Would you like to go back to Corona?

“The establishment of online conferences may reduce business trips, but tourism will return to a growth trajectory. The growing middle class in Malaysia, Indonesia, China, etc. will start overseas tourism once the coronavirus situation is over.”

“There are signs that the country will change. The productivity of the Japanese tourism industry is low because demand was concentrated on holidays. 75% of employment is non-regular to respond to the wave of demand. With the spread of industry, there is a possibility that demand will increase on weekdays. If it becomes established after Corona, it will be positive for the local economy and employment. “

–What is the necessary policy response?

“GoTo Travel’s 35% subsidy rate should be lowered. When the business ends at the end of the corona, the price will rise significantly and the reactionary decline will be large. I would also like to propose that the subsidy promote mass vaccination”

“Above all, it is important to accelerate vaccination and reduce the number of seriously ill people. The next month will be the game for the economy to recover in the summer. Leading Israeli countries and the US and European countries have incentives to relax the restrictions on the behavior of vaccinated people. . We should combine policies to raise the inoculation rate at once. “

――How will Hoshino Resorts work?

“Investors are increasingly entrusted with hotel operations in urban areas where demand is low. Rebuilding operations in oversupplied markets has been important after the collapse of the bubble.”

“I want to expand into North America because it is recognized as a hotel management company in the world. I will do a hot spring inn that can provide added value to Japan. The Japanese company that acquired the hotel in the United States in the 1980s failed because it imitated a Western hotel. I think”

(Interviewer is Arisa Yoshida, editorial board member)

Hoshino Yoshiharu became the fourth representative of the family business in 1991 after graduating from Cornell University Hotel Management Graduate School. 60 years old

Market Update: May 2021

May 11, 2021 | Articles, Global Markets Update

For Accredited Investors Only as defined in the Monetary Authority of Singapore Securities and Futures Act (Cap. 289) and its subsidiary legislation. For Professional Investors Only as defined in the Securities and Futures Ordinance (Cap 571, Laws of Hong Kong) and its subsidiary legislation. This advertisement has not been reviewed by the Monetary Authority of Singapore.

Death and Taxes

Investors in the Asian time zone may not have noticed the that on the 4th of May, the Nasdaq fell by -2.8% at its trough before regaining half of its losses by session close. Maximum losses MTD has been as high -3.8%. The main reason for market skittishness has been the funding for Biden’s two proposed stimulus programs, the USD2.3tn American Jobs Plan (infrastructure upgrade) and the USD1.8tn American Families Plan. The funding for these programs will affect two primary drivers of equity returns, corporate profit growth and tax treatment for capital gains.

The payment for these programs includes USD2tn from higher corporate taxes, a proposed hike to 28% from the current 21%, and USD1.5tn from raising the top capital gains tax to 39.6% from 20%. The latter only applies to individuals earning more than USD450,000 or couples earning more than USD500,000 (the 1%’ers). Already, there are reports that Biden may be willing to consider a 25% corporate tax rate, so there will likely be numerous iterations of the actual amounts. In the case of the impact of taxable income, this accounts for approximately 30% of the investment in US stocks, and while the proportion impacted will be far less, the 4th of May price action indicates the market impact could be significant. One of the most beneficial policies that is less controversial is the USD50bn proposal to improve tax collection for which estimates of additional tax collected range from USD700bn to USD1tn.

While the long-term economic impact of these programs will take many years to discern, the debate of these programs during a seasonal period of lower liquidity could lead to bouts of volatility. The obvious sectors that may be adversely affected are those that benefitted most from the Trump tax cuts, technology, communication services and health care. Industrial, energy and materials benefitted the least. Further, the NASDAQ is up 40% from the pre-COVID peak and is up 100% from the COVID trough in March, and profit taking could be a periodic headwind.

Rising Prices

The SPGS Commodity Index rose +8.2% in April and is up +23% YTD. Together with a slew of reports from companies such as Coca-Cola, Whirlpool, Proctor & Gamble, and even Berkshire Hathaway, that prices are rising sharply and being accepted, investors should be prepared higher headline US inflation numbers in the next two quarters. This is expected. Inflation rises during an economic recovery. The unknowns are how high inflation may rise, and importantly, how much is considered transient. So far, the Fed appears unperturbed and the 10Y UST yield appears to have lost momentum since its March peak. Consensus forecasts for Q2 2021 US CPI is now at 3.2% and has been rising steadily since mid-2020. We should not be overly surprised of a monthly number close to 4%. This quarter is expected to be the peak, with CPI gradually declining for the remaining 2021 quarters. A CPI number significantly higher than 4% or a CPI that does not begin to decline after this quarter may cause concerns.

Source: Bloomberg

Earnings Growth Still Very Strong

The key driver of equity returns, EPS growth, remains very robust. For the US, 87% of S&P500 companies beat EPS estimates by 24% and top line growth surprised by 4%. Discretionary and Financials led the pack. For the Stoxx600, 72% beat EPS by 18% and revenue growth surprised by 7%. Strong EPS outperformance is generally positive for the markets, however, the impact has been subdued in the latest quarter (see chart below). The reasons for this are likely to be many but the crux can be alluded to a sell on the fact mentality. Technicals, valuations, strong YTD performance potential tax increases likely all played a role. Nevertheless, strong earnings indicate this remains more a buy on dips market than a sell on dips.

Source: JP Morgan

Is there a potential for a lull in growth in the US as we have seen in other regions, most notably in China? This is certainly a risk, and higher inflation may exacerbate the impact to corporate profits that will have flow-on affects for markets. However, progress on approving stimulus programs may mitigate the impact of any short-term lull in growth that the most recent jobs claims data might indicate.

Investment Recommendations

Back to the Pack But for How Long?

This month we highlight two stocks that were market darlings last year but have faced a few headwinds recently. These two stocks are Qualcomm (QCOM) and Eli Lilly (LLY). In 2020 these stocks were considered best in class exposures for 5G and Pharmaceuticals respectively and returned 73% and 28% for the year. This year QCOM is down -10% YTD and in March 2021, LLY fell -9%.

QCOM has suffered from 3 main concerns; 1) component shortages, 2) weaker sell-through 3) Apple Inc. deciding to take the wireless modem business in-house. The latter accounts for around 20% of QCOM’s revenues. However, the latest quarterly result showed that 1) & 2) have been well managed through optimizing product mix, solid execution, and increasing opportunities in China from loss of market share by Huawei. Further, despite the gradual loss of the Apple business, consensus revenue growth for the firm is 49% over the next two years and EPS growth is expected to surge by 155%. The 5G story has not changed and the pullback brings the stock to more attractive valuations.

Source: Bloomberg, Odyssey

LLY has had the strongest pipeline among the large pharmaceuticals for several years. One of the most exciting developments has been LLY’s drug for the treatment of Alzheimer’s, Donanemab. In the US, 4.5mn people suffer from early-stage Alzheimer’s so the potential of the drug is huge. In January, an initial Phase 2 trials showed promising results which catapulted the market cap of the stock by USD19bn. However, in March a more extensive Phase 2 trial showed mixed results – the drug cleared substantial amounts of amyloid plaques in the brains of treated patients. But outcomes in secondary trial goals — measures of cognition, memory, and activities of daily living — were more mixed and further study recommended. The result caused the January gains to be wiped out as concerns grew about the efficacy of the drug. These are only Phase 2 trials and a more comprehensive test (results expected in June) is being conducted in preparation for Phase 3 trials later this year. While the results have been mixed relative to the high expectations developed in January, the drug appears at least as effective as its main rival, Aducanumab, produced by Biogen. Hence, the potential remains for this drug to become a blockbuster and highly profitable.

Regardless of Donanemab’s future success, LLY recorded 16% revenue growth in Q1 2021, backed by a strong portfolio in neuroscience, diabetes, oncology and immunology. While the Pharmaceuticals sub-Index has trailed the S&P500 at +6% YTD, should we see a continuance of recent uncertainty over the next quarter, the defensive nature of the industry could lead to outperformance. We continue to see LLY leading the pack as it has over the lasts 5 years with a price gain of 139%, almost 4x the sector return.

Source: Bloomberg, Odyssey

Odyssey Model Portfolio Performance

If you like to receive more information on our portfolio solutions, please contact us here: info@odyssey-grp.com.

Market Update: April 2021

Apr 9, 2021 | Articles, Global Markets Update

For Accredited Investors Only as defined in the Monetary Authority of Singapore Securities and Futures Act (Cap. 289) and its subsidiary legislation. For Professional Investors Only as defined in the Securities and Futures Ordinance (Cap 571, Laws of Hong Kong) and its subsidiary legislation. This advertisement has not been reviewed by the Monetary Authority of Singapore.

April 2021 Insight

All Roads Lead to New York

The first quarter produced solid returns for risk investors overall but proved to be tricky for tech stock investors, small-cap speculators, and long-duration bondholders. A major reason was the rise in long-end yields which questioned the valuation of growth stocks under the glare of potential inflation. The flip side of this argument is that the caution around inflation has been inspired by the rapid recovery in economic growth, particularly in the US. Unlike other regions where the economy faltered in January and February, US PMI has been consistently strong in Q1, underscored by Non-farm payrolls surging to 916,000 in March, 250,000 ahead of consensus. Gains were led by leisure, hospitality, and construction – sectors that had been hit the hardest during COVID.

A potential game-changer is President Biden following up a USD1.9tn relief bill with a massive USD2tn plan to reinvigorate US infrastructure. No doubt the plan will go through several iterations before approval, but despite Republican aversion to taxes, conceptually it should gain bipartisan support. Even spread out over 8 years, this would be a long-term fillip for the economy. As Jamie Dimon wrote in his 2021 letter to JPMorgan shareholders “the economy will likely boom”. Given the strength in the US economy, the potential for further stimulus, and the superior speed of the vaccine rollout (as of April 7, 64mn Americans had been vaccinated), it remains our most favoured investment destination.

Source: Bloomberg

Possible Speed Humps

There are two short-term caveats to our optimistic view on the US. The first is that the long end of the rate curve is likely to continue to rise as the economy strengthens. While the momentum appears to have subsided for now, the absolute level of the UST10Y, as well as the UST10Y-2Y yield differential, remains well below levels in the last decade during “normal” economic conditions, even when the target rate was anchored to zero. Any rapid rise in long-end rates would likely again represent a headwind for growth stocks.

Source: Bloomberg, Odyssey

The second potential short-term headwind is one we face every year. The statistical “Sell in May …” is real, although with statistics we are talking about an average number. In the last 30 years, the May-Sep period returned +1.3% on average and was positive 70% of the time. In comparison, the Oct-Apr period returned +8.4% and was positive 83% of the time. There were actually 5 months with worse average returns than May which returned +0.7%. April, November, and December were the best-performing months. The other noteworthy feature is that the standard deviation for monthly averages was uniformly high at circa 4%. Since the level of dispersion is twice the highest average monthly return, making generalisations can be quite risky.

While these types of statistics should not be relied upon, it does show that, as long as the fundamentals are positive, the May-Sep period can be a profitable one. It’s just that the risk-reward is generally not as good as during the Oct-Apr period.

Source: Bloomberg, Odyssey

Some Respite for Income Investors?

After a strong 2020 when investment grade (IG) credits benefitted from both falling rate yields as well as recovery in spreads from April onwards, 2021 has been a different story. The Bloomberg Barclays Global Credit Index has returned -3.5% YTD. With a lower duration and a 2.75% higher yield, the Global HY Index has fared better with a 1.1% return. The main driver of credit returns this year has been long-end rates. With credit spreads remaining close to all-time tight levels, future returns are likely to continue to be at the mercy of long-end rate movements.

One liquid yield play that has performed well despite rate movements has been REITs. While REIT prices have traditionally shown a negative correlation to the direction of yield movements, recent upward grinding moves of the sector have been due to the recovery in the price to book ratio (PBR) that fell 37% in Feb-Mar 2020. Now that the PBR has recovered close to its 5Y peak at 2.4x, but the estimated dividend yield has fallen to just 3.1% compared to its usual 3.5-4.5% range, the upside may now be more limited. We say “may” because the market cap of many recovery stocks is now higher than where they were pre-COVID, even adjusting for a “normal” operating environment.

Investment Recommendations

Laggard Recovery Plays

The Industrials sector is an obvious recovery play. While the Industrials sector is full of cyclical stocks, in many cases the market has already valued a full recovery despite current difficult trading conditions. Indeed, the US Industrials Index is now 18% higher than the pre-COVID peak and performance only lags the S&P 500 Index by 3%.

One industrial sector that has lagged, but has recently received highly positive news, are cruise lines. On April 7 the US CDC has stated US cruises could resume by mid-summer. Norwegian Cruise Lines (NCL) has already stated it plans to start cruises from US ports on July 4 with fully vaccinated guests. Bookings for H2 2021 have been accelerating in recent weeks and prices have been more resilient than expected. While H2 2021 bookings are still shy of 2019, 2022 bookings are well ahead of 2019 due to very strong pent-up demand. With better guidance in respect to re-openings, the share prices of listed hotel chains such as Hilton and Marriott are already back to, or above, the pre-COVID peaks whereas NCL and Royal Caribbean Lines (RCL) remain circa 40% and 20% respectively below their peaks. For NCL, we like their smaller, more modern fleet that appears at an advantage in the post-COVID environment, and RCL is the premium brand in the sector, a factor we rarely ignore in an early upswing cycle. These stocks can be more volatile than the mega-cap we usually recommend and should be sized accordingly.

Source: Bloomberg, Odyssey

Social Media is All About the Camera

We’ve been encouraged by our recent positive calls on Facebook and Google. Another we have liked since their blockbuster Q4 result is Snap Inc (SNAP). The stock then fell 30% due to rising rates but has since begun to climb back up. It’s not a cheap stock on traditional measures but management’s recent rare claim that they believe revenues can potentially grow by 50% for several years means short-term valuations do not capture the embedded value in the business. For instance, Snap’s ARPU is currently less than 10% of Facebook’s. That’s a lot of upside for a company that is widely acknowledged as one of the most innovative among social media platforms, thereby maintaining its “lit” status among the young. Many of Facebook’s features appear after Snap first introduces it on their platform and this is likely to continue. Indeed, Snap is now designing products it says are more difficult to replicate and many of these revolve around the phone camera. In addition, they are doubling down on what they believe is the next evolution in computing, augmented reality (AR). Revenue growth of 62% in Q4 2020 demonstrates its leverage to the recovery in ad spending, but it also underscores the structural growth story of harnessing social media among a younger audience.

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