Inflation might be main thing on investors’ minds at the moment but getting the inflation outlook right isn’t the only key to a successful equity portfolios, according to Artemis fund manager William Warren.
Warren, who holds FE fundinfo Alpha Manager status, manages the £511m Artemis US Extended Alpha fund and the £212m Artemis US Absolute Return fund.
He believes there are five events going on in US equity markets that are presenting him with long and short investment opportunities. We take a closer look below.
The world’s most exciting stocks aren’t semiconductors
Semiconductors have emerged as a major investment theme over the past few years, serving the ongoing technological shift and adoption. This picked up in the past few months with a global semiconductor shortage causing a surge in the stocks.
But it’s further down the supply chain where the “decade-long megacycle” opportunity is, according to Warren – in the builders of the equipment needed to construct semiconductors.
The annual capex on equipment by semiconductor companies has been increasing and, according to Warren, is set to go higher, doubling from the current $50bn per annum by 2023 as the importance of this part of the supply chain grows.
“In fact, we believe capex in this industry could move to a permanently higher level,” Warren said.
A major driver of this is the macroeconomic factors of the US, Europe and China’s battle over technology and supply chains as the former want to be less reliant on China for semiconductors.
Both countries have therefore been increasingly re-shoring semiconductor plants used in areas of the “highest strategic importance” such as defence. The building and expansion of these sites will require a vast amount of equipment, driving this theme.
“The need to invest is multiplied by the increasing technological challenges semiconductor producers face (as Intel’s recent struggles have shown) in matching Moore’s law,” he said.
In Artemis US Extended Alpha and Artemis US Absolute Return, Warren has reacted to this trend by taking long positions on stocks such as Lam Research and Applied Materials.
“We believe these companies represent far more exciting investments than ‘software as a service’ (SaaS) and internet stocks, which will need to deliver rapid revenue growth to justify their white-hot valuations,” he said.
“To deliver that, they will need to invest in data centres, which in turn means more demand for semiconductors – and so for the products of Lam and Applied Materials.”
Great times for US housebuilders
There is currently a misalignment with the amount of new housing available in the US and the demand for it, according to Warren, with a “massive undersupply of housing stock”.
He said this is due to the millennial demographic now entering the housing market.
Stocks such as DR Horton, Lennar and KB Homes are all plays on this theme within the funds as Warren said: “[They] can sell everything they can build for far higher prices than some analysts have plugged into their models.”
Too early to sell out of value
Although getting the inflation call right isn’t the only thing to focus on, inflation itself has become a bigger part of market outlooks.
The US has seen a surge in inflation as the latest data from the US Labor Department found that US inflation increased by 5 per cent in the 12 months through May, making it the largest yearly increase since August 2008.
Heightened inflation expectations are intertwined with the path of value stocks and particularly for Warren whether now is the time to sell-out of value assets.
“Our base-case scenario is that, due to a confluence of factors – such as the expiry of rent-payment holidays, disruptions to supply chains and the resumption of spending on travel and leisure – some inflation is coming,” Warren said.
“Because we believe inflation expectations have further to rise, we believe it is still too early to take profits in the ‘value’ factor.”
The value versus growth theme has been a major story in markets for the past few months as global indices have undergone the first substantial rotation out of growth and into value for several years, fuelled by rising inflation expectations.
This has partially closed the gap between value and growth stocks from what Warren called the “unusually wide” levels a year ago.
“Yet even from these levels, market history suggests that maintaining a bias to value should lead to continued outperformance, albeit at a more modest pace than seen over the last six months,” Warren said.
“So it is too soon to sell financials, a sector where P/E multiples relative to the wider market tend to correlate particularly closely with inflation expectations.
“We therefore retain meaningful long positions in stocks such as Ally Financial (auto loans), Synchrony (credit and store cards) and Citigroup.”
Growth and momentum decoupling
Another part of the growth-value story playing out is the “decoupling” of momentum and growth.
As growth stocks led markets for years, they became synonymous with momentum. But the recent shift into value has broken this relationship. Now Warren said, some value stocks which are exhibiting price momentum are displacing growth names seeing a price drop in momentum strategies.
“Thirty years of market history also suggests that, after a very poor run, there is not a great deal further for the momentum factor to drawdown. If – or when – momentum recovers, then the beneficiaries won’t always be growth stocks,” Warren said.
This means that some growth stocks have been ‘de-risked’ and “therefore, are no longer simply a proxy for market risk – so we can hold the best of them without taking an outright bet on market direction”, Warren said.
The growth stocks he is focusing on is those with high free cashflows, high free cashflow margins and have reasonable multiples of earnings relative to growth rates.
“To be crystal clear, however, we are not talking about ‘concept’ stocks with stratospherically high P/E multiples or with no cashflows at all,” Warren said, instead leaving them as shorting options.
In this environment Warren said that it is “the right time to run a growth/value ‘bar-bell” approach. Names such as Google and Facebook (“quality, cash-generative”) make up the growth side and industrial stocks such as Caterpillar and Sherwin-Williams and beneficiaries of the ‘re-opening trade’ make up the value side.
Robinhood has forced a change in short selling policies
The Robinhood episode back in January stunned markets at the time and has challenged the way short selling is carried out, according to Warren.
“Short selling amid the ‘everything rally’ has been a challenge. That challenge has been intensified by the popularity of trading apps such as Robinhood, which have brought new cohort of day traders into the market,” the manager said.
“As the GameStop fiasco showed, when they co-ordinate their actions these individual traders can represent a powerful force – and deliver painful short squeezes.
“Although our strategies weren’t caught up in the GameStop squeeze, this is not the time to be complacent about the (increased) risks of a short squeeze.”
As a consequence of this, Warren revised his shorting policy and now if the manager wanted to fully exit a position it has been reduced from five to three days.
One part of the market which is “ripe for shorting” is the US grocery retailers, Warren said, an industry facing structural changes as the likes of e-commerce giant Amazon now appears to be targeting.
Other areas he is focusing his short positions are growth names “where valuations seem to embody a huge degree of hope”. These are stocks with shares trading on multiples at least 20 times higher than its sales.
“To reiterate, however, we are not predicting the bursting of a bubble; we are long of ‘growth’, and particularly of secular growth,” Warren added.
“But with bond yields having the potential to move, it seems wise to be wary of companies who need deeply negative real rates to prosper.”