Ivy International Core Equity Fund - Investment Update
Commentary as of December 09, 2020
We've entered a period where the markets have been more focused on stocks with lower valuations. What do you think has been driving this rotation towards value-oriented stocks and do you think this rotation is sustainable?
Catherine: The primary reason for the rotation is that inflation expectations are starting to increase from very low levels seen in March 2020 due to COVID-19 related pressures. This is a positive for financial sector stocks, but more importantly it's a negative for growth stocks because the discount rate starts to rise. Central banks around the world, including the U.S. Federal Reserve (Fed), are committed to easing monetary policy so there's still plenty of recovery left in terms of inflation expectations. Purchasing Managers’ Index (PMIs) and gross domestic product (GDP) expectations are accelerating on COVID-19 vaccine news, which is in turn also a positive for value stocks. We are also beginning to think about what the Biden administration is going to do on things like taxation of eCommerce and other regulatory actions regarding privacy and monopolistic practices of larger eCommerce players both in the U.S. and across the globe. The U.S. dollar is beginning to decline given inflation expectations, and yields are being pushed up because of the debt being issued by the U.S. Therefore, we believe this increased focus on value stocks has taken a fairly sustainable turn. This doesn't necessarily mean that growth stocks will fall, it just means that value stocks are likely to continue to accelerate for the next 12-24 months.
John: Valuation metrics today between growth stocks and value stocks have never been wider. The first pandemic in 100 years has led to the greatest global stimulus on record, and it's very likely to lead to a change in the macro backdrop of which stocks you want to own. The U.S. dollar is declining which tends to be beneficial for emerging markets and international stocks in general. The market cycle since the Great Financial Crisis has been one of the longest on record, and it's also been the longest momentum rally on record. We've seen these momentum bubbles play out before. There were several stocks that reached extremely high valuations during the tech bubble of 2000 which subsequently fell in value and have never returned to those valuation levels from that time period. The exact timing is unclear of when the market starts to correct these valuation imbalances, but we're getting very close to that point in today's market. Value stocks look very promising going forward.
There have been some changes made in the portfolio in recent periods. Can you walk us through some of the more meaningful shifts and the rationale behind those moves?
Catherine: Within financials, we haven't made many changes since September. Most of the significant COVID-19 related repositioning we did within the financials sector was done in the April-June period.
John: We've stayed on the value edge of the core box. We're deliberately avoiding perceived expensive stocks. We're looking at the market and shifting towards what we believe are underappreciated stocks that will benefit from opening up, particularly those with attractive free-cash-flow yields going forward. We're getting into stocks that we are finding inexpensive given the current environment. We're also looking at stocks we believe have been oversold this year. We're most excited about stocks where we find value as well as catalysts given the prospects for opening the economy again.
China has recently announced its 14th Five-Year Plan which emphasizes higher urbanization, infrastructure, being less dependent on other countries, and reducing carbon emissions. How do you expect this development to affect how you view your investment universe?
Catherine: Frankly, I don't think it will affect much. The plan is consistent with what China has been doing for the last five to ten years. They've been working to finish the industrialization of China by 2025 and transition to a consumer-oriented economy. This plan attempts to continue to accelerate that – China is very committed to becoming self-sufficient. As far as the portfolio is concerned, our major concern around China at this point is regarding the U.S. potentially delisting Chinese securities if they don't comply with U.S. law within the next few years. Under the Biden administration, we don't know yet how that will play out so we'll have to wait and see. We've begun selling some Chinese stocks due to these concerns.
2020 has clearly been an interesting year from many perspectives, including within the investment world. What is your outlook on the international equity landscape for 2021?
John: I think the market will broaden. In 2021 we should get to a period where we get the opening-up trade, and we get a reasonable portion of the wealthier population to begin engaging in experiences and services again. As that part of the economy opens, we believe it will do well. Tourism is a huge part of Europe and makes up to 10% of GDP in some countries. Tourism revenues will go from zero to positive and that will help a lot. But this isn't the only example. Basically, there are many inexpensive value stocks out there that we are finding much more attractive than expensive growth stocks which could be significantly adversely affected if and when this bubble bursts.
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