US equities have lagged significantly over the quarter, reversing some of the outperformance seen so far this year. The vaccine announcements meant that the sectors most represented in the US market, such as technology, have underperformed as investors have sought to reallocate to companies that are likely to benefit most from a reopening economy.
The additional impact on US equities has been the continued weakening of the US dollar. A weaker dollar has a greater impact on US returns to foreign investors as a larger proportion of the S&P 500 earnings are domestic, compared to other national indices (eg.UK). A weaker dollar will mean that it is likely that US equities will underperform, all else being equal.
We maintain a slight underweight positioning to US equities, reflecting their high valuations relative to the global equity market and that they will not benefit as much from a resurgent global economy, given the sector makeup.
For the first time since Q4 2019, UK equities have delivered an outperformance against international peers. The sector makeup of the UK market that has been such a headwind for a large part of 2020 lifted the market as investors attempted to reallocate to those unfavourable areas (eg. financials, energy). However, the broader macro tailwind for UK equities was tempered slightly by the ongoing Brexit negotiations which at times led to further discounting of domestic companies and the currency, and no doubt continues to cause a risk premium over UK equities.
Despite a strong quarter, the UK continues to be one of the cheapest markets and remains good value on an absolute basis.
We have continued with our long-term process of reducing portfolios bias towards UK equities. This is not reflective of our shorter-term outlook for the asset class but rather to ensure that portfolios are not unnecessarily exposed to specific areas. While there is a strategic long-term reduction in the UK equity allocation, we have maintained a slight tactical overweight.
The Asda income tracker for September was released in the quarter. The high-level measure has improved significantly over the last three months. Although there have been job losses, these have typically been focussed on lower paid roles (those households that do not generally have high disposable incomes) and inflation remains low. With limits on when and where consumers can spend income, the data also suggests that there has been a build-up of savings and demand, that could be released once restrictions are moderated or lifted entirely.
European equities have performed in line with global peers as investors looked to strike a balance with the clear benefit to European stocks from a more bullish global economy but also the shorter-term headwinds of Coronavirus restrictions still in place across much of the continent. Indeed, the announcement of a countrywide lockdown in Germany from mid-December illustrates that the issue by no means has gone away. There is now widespread disruption within Europe from government lockdowns, exacerbated towards the tail end of the quarter by the spread of a new variant.
We have a slight underweight to Europe, as although valuations are in line with global peers, there are specific structural as well as shorter term issues. We are cognisant that European equities will perform well in a cyclical global economic recovery, however, we feel that the portfolios will do well in this scenario due to the allocations to the UK among others.