Mixed performance in February: our long-only unhedged Fund, SF Quality Stocks leads returns posting +4.07% (+3.86% YTD), followed by SF Prudent Growth with a raise of +.096% (+2.84% YTD), and SF Real Return – less benefited from the rally at the beginning of February– -2.13% (+2.11% YTD), while the MSCI World ends at +2.89% in EUR (+2.59% YTD, also in EUR).
February started with sharp market rallies, boosted by positive developments in the fight against Covid-19 and encouraging corporate results, especially those of companies that not only have done well during the pandemic, but also have high expectations for 2021 and 2022. Since market rise was in line with improved profits, prices have not actually increased in terms of multiples. This is precisely the positive market backdrop on which our long-term strategies and share positioning are based.
In the second half of February, a large part of the portfolios’ returns was given back when markets rotated towards industries severely punished by the crisis. Although our shares fell from maximums, our hedging strategies helped offset some of these losses since in times of rotation, share indices’ absolute value rarely fall significantly. The worst performing index since February 15 was the Nasdaq, although the fact remains that it is the top performer from a long-term perspective, and it would be unwise to short this index.
Our stance is to continue to be invested in companies with the best long-term earnings perspectives, and to flexibly manage hedges to protect the portfolios against market falls. Although when markets don’t actually fall but are simply rotating, engaging in this flexible hedging management is more complicated, these episodes are usually short-lived. Our strategy in such cases is to avoid being short in rising industries, even if we do not consider them attractive in the long-term, and to capture returns by selling options and volatility, on the back of indices’ solid support levels. Returns thus captured, whose contribution to global returns is not easily visible, usually add considerably to YTD performance. In this particular instance when the USD fell, we added to our long exposure, as the US seems to be recovering from the crisis much quicker than Europe.
At current market levels (March 8), larger capitalization companies on the S&P 500 and Nasdaq are considerably undervalued, especially when growth is also factored in. In addition, mid-capitalization companies’ prices have also fallen from maximums, providing excellent entry opportunities. We believe price dispersion among cyclical companies and secular growth companies should not widen further, and we expect secular growth companies to outperform over the next few months.
From a macroeconomic perspective, we feel the recent correction in growth companies’ prices cannot be explained by the anticipation of a disorderly inflation rise, since instruments whose prices are most directly affected by their future development have barely fluctuated. In addition, it is unlikely that short term rates will vary much in the near future, and Central Banks will continue to maintain expansive policies as long as no inflationary pressures emerge in the labour markets. In fact, the recent fall in government bond prices was largely triggered by the expiration at the end of March of some of the ultra-expansive measures launched by the Fed to counteract the crisis, that allowed banks to have a higher exposure to fixed income risks than usual. This induced sale by banks was interpreted as an increase in inflation, and fear swept across markets. Although fixed income rates are slowly returning to normal, our perception is that inflation has not peaked to levels at which Central Banks cannot control it easily, now they have an unlimited amount of ammunition set aside for this purpose.
On the upside, the battle against Covid is well under way and the outcome is as positive as anticipated. By summer this year, mobility restrictions may have decreased significantly (if not in all countries, at least in many) and economic recovery could also pick up speed; this economic recovery will not only be positive for overall sectors but will benefit leading and niche growth companies as well, and it is important to take advantage of any correction in these sectors to enter or add to existing investments.