4th Quarter 2020

Markets were again very strong in Q4, driving many equity markets well into positive territory for 2020, a remarkable recovery from the lows seen in March. Markets were ultimately supported in 2020 by unprecedented levels of monetary and fiscal stimulus, though Q4 saw the result of the US presidential election and development of vaccines for COVID-19 to push markets to highs. There is good reason to expect a strong economic recovery in coming years. Household finances are in good health and government spending is expected to remain at high levels, all the more so following the Democratic victory in the US elections. In a polarised world, one of the few consensus policies is not to engage in fiscal austerity.

Asset valuations, government spending and economic recovery are all predicated to a greater or lesser extent on low interest rates. Price-earnings multiples are more in line with historic averages if adjusted for government yields. While government spending is high, the interest cost to governments is forecast to actually fall for coming years given the significant drop in interest rates, similarly for corporates where leverage has increased significantly in 2020. The question is what can alter that interest rate environment. This is likely to be inflation. Inflation has remained muted since 2008 and consistently undershot expectations. If inflation does come through, the policy response could be significant. The easiest way to reduce national debt as a % of GDP is to allow growth of nominal GDP. Central banks, notably the US Fed, has said that it will not raise interest rates automatically in the face of inflation, but look through a cycle. The risk is that inflation accelerates beyond a tolerable level and it becomes perceived that central banks are behind the curve on raising interest rates, which leads to an unexpected and sharp rise in interest rates.

We are very excited by the investment opportunities we see across a number of strategies. We are in an environment where prospective returns from traditional investments are at the very least lower than they have been. Yields on high quality bonds, especially sovereign, offer minimal returns and potentially losses in real-terms. Equity returns are likely to be very specific with winners and losers arising from structural changes in individual and corporate behaviour following the COVID-19 pandemic.

We feel that hedge funds are a compelling investment in a variety of strategies; relative value strategies to generate traditional bond-like returns with limited beta to markets, equity focused managers identifying the winners and losers in a rapidly changing landscape or private credit to take advantage of stress and over-leverage within corporate structures as business models are challenged. Stenham, with our experienced and stable investment team, is very well positioned to help clients take advantage of these opportunities.

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