There will be a global market correction before the end of the year but investors are not investing for it, according to Argonaut Capital Partners chief executive Barry Norris.
The manager of the £27.6m VT Argonaut Absolute Return fund made more than 15% in March last year when the market collapsed at the start of the pandemic.
He said another such fall could be on the way before the end of the year and that investors should make changes now to account for it.
Total return of fund vs sector since January 2020
Source: FE Analytics
Much of this is due to a resurgence in Covid, with the government outlining a winter plan to deal with a rise in cases over the next few months.
“In my view, the expectations for vaccines are way too high. Originally people thought if they were double vaccinated they would never get Covid and most cases in the UK are now from people with two vaccines. It is not showing any efficacy at all in regard to transmission,” Norris said.
The vaccine will not eradicate the disease, he said, meaning that the although the numbers of hospitalisations and deaths will fall this winter, this will not be enough from a political standpoint and will lead to further lockdowns.
“In China, one case of Covid caused a port closure for two weeks, which caused ships to be stationary and shipping rates to go through the roof. Therefore I think we have to prepare for the disruption to be a lot longer lasting than what anybody had previously thought,” he added.
This will not only affect industries such as travel, leisure, retail and property, which have all been hit by government measures to tackle coronavirus, but will also have an impact on inflation, which the Office for National Statistics (ONS) revealed today jumped a record 3.2% in August.
Norris added this could exacerbate already problematic supply shortages among semiconductors and shipping, negatively impacting companies that will be hit by higher material and shipping costs.
This comes at a time when central banks have “shot their bolts” and can no longer afford to keep schemes such as furlough running, while inflation will make lowering interest rates a difficult task.
The recovery after March last year, shown in the chart below, was supported by monetary stimulus, fiscal deficits and an expectation that Covid would end with the vaccine rollout.
Total return of fund vs sector over 10yrs
Source: FE Analytics
“All three of those have big question marks over their sustainability and given the run in markets the risk reward in equities has shifted and there is a high probability of a significant correction by the end of the year,” he said.
“We’re going to be in a difficult place unless the politics changes globally and all of the things that rode to the rescue last March are one-offs that cannot be repeated.”
To combat this, the manager has taken out more shorts in his controversial portfolio, which is an outlier in the IA Targeted Absolute Return sector. The highly volatile fund has been one of the sector’s best performers, returning 91% over the past decade, but has had much higher peaks and troughs than its rivals.
Norris has increased the short positions in his fund from 50% of net asset value to 75%, with around a third in industries expected to be hit by a second Covid wave.
The other two thirds are in companies that have “fraudulent business models”, which in downturns “tend to be uncovered and unravel a bit more quickly”.
There are also opportunities within the market for stock pickers, but Norris warned that buying the high quality, defensive stocks that have worked in the past may not be the answer.
“They will be affected negatively from rising inflation which will hit profits and have a knock-on effect on the multiple that people will want to pay for the stocks,” he said.
Instead, he has bought cyclical companies such as shipping firms, semiconductor firm, fertiliser businesses and power utilities, that will benefit if Covid remains an issue.
His largest holding is Gazprom, the Russian gas producer, which is near a record high in Europe, he said, as there has not been enough money invested in finding new sources of gas.
“The stock trades on four times earnings and has a 15% dividend yield. In a global market that is pretty expensive 80% of my longs trade on less than 10 times earnings and will be resilient to the downturn,” Norris added.