January 13, 2021
Princeton Global Fourth Quarter 2020 Investor Letter
Global equity markets continued to recover from the March 2020 lows during the fourth quarter. In addition to accommodative monetary policy, expectations that vaccinations against COVID-19 would result in herd immunity and a return to normal economic activity sometime in 2021 provided the impetus for higher equity prices. The beneficiaries of improving economic activity led the positive performance, resulting in equity markets leadership broadening to Small-Cap, Mid-Cap, and International stocks beyond U.S. Large-Cap Growth stocks. One of the many extremes of 2020 was the divergence between the S&P 500 Growth Index (+33.5%) and the S&P 500 Value Index (+1.4%). International stocks reversed the trend of recent years and led in the fourth quarter.
The key question surrounding the future trend in equity markets is the timing for the pace of vaccinations against COVID-19 to reach a significant majority of the global population and enable the global economy to return to normal. Unsurprisingly, the enormous task of vaccinating billions of people worldwide begins with solving the logistical hitches revolving around the distribution of vaccines and the actual injections. There are reasons for optimism that these logistical problems will be resolved in the coming months. A sufficient percentage of the population can be vaccinated during 2021 to permit global economies to exhibit substantial recovery.
More immediately, economic activity in the U.S. is showing signs of a slowdown. The accompanying problems will be mitigated in part by the approval of a new $900 billion stimulus program late in 2020. With the arrival of a Biden administration on January 20 and Democratic control of both the Senate and House of Representatives, there is a strong probability of further stimulus in the coming months. The additional stimulus will attempt to limit further damage for the most vulnerable sectors of the economy, such as travel and hospitality, and give more assistance to state and local governments. Simultaneously, highly stimulative monetary policy should continue for several years, given the Federal Reserve’s focus on restoring full employment and a willingness to allow inflation to run above the 2% target for an extended period. Once the maximum negative impact of COVID-19 has passed, there is potential for robust economic activity as pent-up demand for activities such as eating in restaurants, entertainment, and travel explodes.
There are signs of froth within equity markets, exemplified by sharp upward moves in some initial public offerings and select stocks and investment types. In a few emerging industries, we see parallels to the speculation of twenty years ago when stocks were being valued on excessive price to sales multiples and “alternative” valuation techniques. Electric vehicle-related securities and Bitcoin come to mind as two current examples of investor euphoria.
The relative returns of Bitcoin have trounced other “bubble” assets of the past:
While equity markets are likely to exhibit above-average volatility, the building blocks for further advances in share prices overall remain in place. These include the lack of attractive alternatives, with fixed income yields remaining at historic low levels—for example, the yield on 10-year U.S. Treasuries is hovering just over 1.0%. This scarcity creates a continued built-in demand for equities as institutions such as pension funds seek to meet long-term obligations. Fuel for further share advances is continuing to be provided by the Federal Reserve’s accommodative monetary policy, which, given the focus on full employment, will not be reversed anytime soon.
Internationally, developed markets have performed better in the fourth quarter and anticipate economic recovery as the pace of vaccination accelerates. Europe has also provided significant income support to the most affected people, and infrastructure spending in Europe and Asia will likely surge this year to rebuild the economies. Emerging markets gained sharply on a V-shaped recovery in manufacturing, aggressive monetary and fiscal easing in most countries, and a “mini-boom” in the Chinese economy. Overall, the emphasis on recovery beneficiaries should continue to outperform, as has been the case since early September.
We continued our efforts to invest in companies emerging from the recession in a position of strength during the fourth quarter. We are focused on new ideas in industries that will benefit from the eventual “re-opening” of the global economy and stimulus packages, including stocks in the Consumer Discretionary, Industrials, and Materials sectors. We have maintained overweights in the Health Care and Information Technology sectors. The Health Care sector remains our favorite “non-cyclical” sector due to its attractive combination of earnings growth, dividend growth, quality, and reasonable valuations. The Technology sector exhibits strong prospects, but after several years of strong price performance, the sectors’ valuation looks “priced to perfection” and a source of funds for other investments with less regulatory and corporate tax reform risk.
Health Care industries have an attractive blend of growth and low valuations. Tech sector fundamentals remain attractive, but valuations are now elevated:
U.S. stocks have performed significantly better than International stocks over the past decade-plus. U.S. stock outperformance has been driven by consumer-led economic growth, attractive sector composition (e.g., more Tech, fewer commodities), and accommodative monetary policy. We have favored U.S. stocks in our strategies over International developed market stocks. However, the wide valuation discount of International stocks to U.S. stocks, improving relative performance, and a weaker U.S. dollar leads us to focus on multinational companies domiciled overseas. We continue to see an attractive long-term outlook for Emerging Market equities.
International stocks look “cheap” compared to the U.S. based on price to earnings and dividend yield:
Our Dividend Growth strategy finished a strong year of performance, particularly compared with other equity income funds. The positive returns were led by the Technology sector holdings and growth-orientated investments in the Health Care, Real Estate, and Utilities sectors. We have high-conviction a dividend growth investing approach is prudent and well-positioned for the current environment. The average stock in the strategy has a dividend yield of 2.5% and is projected to grow the dividend over 8% annually in the next several years, which compares very favorably to the yields of other income-orientated investments.
Our Global Equity strategy performed well in 2020 and met its capital appreciation and flexible diversification objectives. Our large-cap growth-orientated holdings led the positive returns, particularly in the Semiconductor, Software, and Life Sciences industries. The Financials sector did not perform well in 2020 yet remains one of our favorite pro-cyclical sectors in 2021 due to the outlook for improving credit trends, favorable capital allocation, and the increasing probability of a steeper yield curve. We are evaluating decreasing our Large-Cap Growth positions in favor of the pro-cyclical industries mentioned above.
After a challenging beginning to the year, our managed Exchange Traded Fund portfolios performed well in the second half of 2020 as Small-cap, Mid-cap, and International stocks recovered on the “acceptance” of an economic re-opening. Our global diversified equity exposure remains tilted towards Dividend Growth, Quality, and Mid-Cap fund styles. We continue to see value in investment-grade Preferred Stock funds for higher-yielding exposure to complement our short-duration investment-grade holdings within fixed income.
Regardless of the equity sector or geography, we continue to view Quality as an essential characteristic for holdings and new purchases.
Fixed Income Strategy
During the fourth quarter of 2020, short-term rates remained anchored by the Federal Reserve’s zero-interest-rate policy, while yields on Treasury securities with maturities of five years or longer increased slightly. As of year-end 2020, the respective yields on five-, ten-, and thirty-year Treasury obligations were 0.4%, 0.9%, and 1.6%, respectively.
Given the Federal Reserve’s focus on full employment, there is little prospect of a change in its zero-interest-rate policy and aggressive approach to quantitative easing any time in the next several years. However, an increase in longer-term rates seems likely. The unprecedented level of fiscal stimulus will lead to a deluge of U.S. government securities offerings, placing upward pressure on longer-term rates. Even a modest increase in longer-term rates would result in significant price erosion at current low levels:
We continue to maintain a shorter than average duration in our taxable and tax-exempt fixed income portfolios with these risks in mind.
Given the potential for above-average volatility in the immediate future, communication remains a top priority. Please do not hesitate to contact us with questions or concerns at any time, whether by calling, emailing, or videoconferencing our team.
Princeton Global Asset Management, LLC
This report is for informational purposes only and contains data based on information from Princeton Global Asset Management (PGAM) believed to be accurate. However, PGAM cannot assure the accuracy of the data.
Past performance is not a guarantee of future results. Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security.
It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.