A Change in the Air
The announcement by Pfizer of positive trials for an effective vaccine has lifted markets which just confirms how important confidence is in lifting the world out of this depression and providing hope for the future.
Of course we have been here before and the recent trials seem to have only been on those aged under the age of 55 and it is not clear whether it helps prevent you getting the virus or just reduces the symptoms, nor do we know if there are side effects. It is for this reason Boris Johnson warned everyone not to get too excited. For conspiracy theorists one wonders why the announcement was made post the US election?
No matter, there are several other players in the market who may too have an effective vaccine if this one does fail and additionally treatment of those affected has improved, all pointing in the way to a route to learn to live with the virus and get back to normality.
The S&P 500 has hit new highs ( The FTSE 100 index is still down -15.66% YTD despite the recent rise) largely led, up to the third quarter, by the FAANG stock often referred to as growth plays. FAANG stocks have historically outperformed the S&P 500 index and since the market bottom in March of 2009, the worst performing FAANG stock, Apple, has returned more than double that of the index average. They currently make up about 25% of the value of the index.
Whilst the FAANG stock have soared this year it doesn’t mean that these companies will continue to grow at the same rate or that they are not without issues. It is no secret that the Democrats want to bring in antitrust legislation to break up the monopoly of these firms. When that last happened to Microsoft they remained in the doldrums for a decade. So what are the possible detractors to future performance?
• Facebook: Facebook's business model is essentially selling a user's information to advertisers, not a subscription model. Additionally, governance at Facebook is and has been an issue. Founder Mark Zuckerberg wields significant power and authority which at times has been un-checked.
• Netflix: Netflix appears to be overearning today and is spiralling in an ever-expanding cycle of content investment. By contrast, Time Warner, has a high return on content with HBO and was able to perpetuate a customer cycle with little marketing costs. Netflix is the opposite. People typically come for one show and then stop. Therefore, Netflix must invest more and more to grow subscribers, which is very different, and yet to be proven as a sustainable profit strategy.
• Apple: Apple has done a great job in building the Apple ecosystem with a variety of products leading to well above average gross profit margins. In the cellular phone market for example, Apple has been able to earn twice the gross profit margins of their competitors. Given that many of the components embedded in those products are shared with competitors, this ecosystem loyalty is the main driver. This possesses a level of risk to the sustainability of those higher gross profit margins.
• Amazon: Amazon earns all of their profits from AWS (Amazon Web Services), providing cloud based marketing infrastructure to third party retailers, but Microsoft's Azure has taken market share. Amazon's core business of delivering retail products to consumers has yet to demonstrate profitability. Amazon Prime which allows access to the streaming of movies and TV episodes; and other services suffers from many of the same factors noted with Netflix.
• Google (Alphabet): Like Facebook, their business model is essentially selling a user's information to advertisers, not a subscription model.
While there is a strong rationale for outperformance during COVID, current valuations need to be considered. The P/Es of Amazon and Netflix are 103 x and 102 x respectively, in comparison to the S&P's 20 x, suggesting there is currently more value to be found elsewhere. The Pfizer announcement sent some of the growth stocks tumbling with Zoom down 17%.
There is evidence that cyclical stock and value plays that have lagged are coming back. Indeed, over the month of October this style of manager with SJP outperformed the growth plays.
It is interesting to note that Hamish Douglass (SJP International Equity Fund) has taken profits from his holding in Apple and James Anderson, manager of the Scottish Mortgage Investment trust (Irongate Bespoke Equity Portfolio) has started to sell down Amazon for the first time questioning the ability of the US internet giant to be able to maintain their rapid share price growth. What this demonstrates is that holding a diversified portfolio is vital. Stock selection is as important as ever and managers will be seeking the recovery plays as well as taking profits from companies that have benefitted from the lockdowns.
Optimism is in the air. Veteran businessman, Sir Martin Sorrell a renowned bellwether is convinced that there will be a global recovery in 2021 citing growth forecasts from Goldman Sachs predicting GDP growth of 6% next year mirroring positive views of Capital Economics.
The opinions expressed are those of Irongate and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by St. James’s Place Wealth Management. The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.