The recovery is yet to come

With vaccination programmes well underway and the outlook for the economy improving, we at The Scottish have been paying particular attention to ‘reopening’ stocks – those poised to benefit from a return to economic normality.

One year ago, the economic damage from the unfolding coronavirus pandemic was unquantifiable. It was unclear when, or indeed if, a vaccine would be available. Shares in companies most reliant on a buoyant economy were, rightly, marked down.

Of course, vaccines have now transformed the prospects for recovery, but with valuations of many stocks still not reflecting the improving outlook, we believe that some investors are underestimating the potential rebound.

As pent-up demand is released, the companies that will see the greatest benefit are likely to be those that have been overlooked in recent years.

Exceptional measures

The vaccine is not the only salve bolstering the economic outlook. Massive stimulus programmes from central banks and governments have ensured that consumers and businesses emerge from the crisis in a more robust state than in previous downturns. This should accelerate the rate of recovery.

Stimulus has other side effects worth keeping an eye out for. Signs of recovery could continue to drive bond yields higher – albeit from a very low base. This matters as higher bond yields reduce the present value of future profits. In other words, higher yields favour companies that can make profits now. Historically, ‘value’ investments outshone their ‘growth’ counterparts in such conditions.

Unexpected winners

Many ‘value’ sectors face structural changes that obscure the winners within them. Retail is a prime example. The high street’s struggles have been well documented, but the shakeout of weaker competitors ensures that the survivors with attractive brands and strong digital strategies gain market share, potentially doing rather well. Likewise, companies that have been quietly working to improve their prospects have also seen them masked by the economic turmoil, presenting a greater opportunity to surpass historic margins.

To take advantage of such opportunities, we have added stocks such as H&M, Capri Holdings, Cheesecake Factory, Six Flags Entertainment and Whitbread, which are well placed to benefit when consumers are free to start spending offline.

We also see compelling opportunities in the financial sector, with banks being direct beneficiaries of rising yields and improving credit trends. Our additions in the sector include Wells Fargo, First Horizon and Santander. Additionally, in the often-overlooked life insurance industry, we favour the restructuring underway at both Aegon and Aviva.

Another opportunity lies in unloved cyclical stocks sensitive to economic activity. Here, we have increased exposure to energy stocks, such as Halliburton and Helmerich & Payne, as well as industrials like General Electric.

The value of gold

The other side of the recovery is the potential return of inflation. The extraordinary fiscal and monetary interventions we’ve seen worldwide will, inevitably, have consequences. Many people assume that central banks will intervene to stop inflation, but that assumption may be misplaced.

Already, the US Federal Reserve has indicated that it is willing to maintain its exceptionally accommodative stance and tolerate higher levels of inflation. After all, it whittles down the value of the eye watering levels of debt governments have accumulated during the pandemic. The conclusion as to whether current high inflation levels are “transitory” or not remains to be seen over the coming months.

We think that many investors are still underestimating the combined inflationary effect of massive stimulus and a population eager to start getting out and spending again. And once the inflationary genie is out of the bottle, it could prove difficult to control.

That’s why gold remains central to our strategy. Unlike fiat currency, gold holds its value in the face of inflation and gold miners should respond in these circumstances. We see them as beneficiaries of the post-pandemic environment rather than defensive investments. Our holdings include some of the world’s leading gold miners, including Newmont and Barrick Gold.

Not just a warm-up

The recent additions to our portfolio have fundamental opportunities to improve their prospects as well as the potential to capitalise on the environment that we see developing. Many of them operate in areas of the economy that were already unloved and depressed – as contrarians, that’s why we’re optimistic, not only when the weather warms up.

16 July 2021

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments.