LIC L1 Capital bullish on equities, sees inflation overshooting expectations

L1 Capital expects a major market rotation from cash and bonds to equities, and from growth to value stocks as the global economic recovery gathers pace.

L1 Capital is bullish on equities and expects to see a large rotation from bonds and cash to stocks as the economic recovery gathers pace. Picture: AAP

The global economic recovery through 2021 will deliver a major market rotation from bonds and cash into equities, and from growth to value stocks, according to listed investment company L1 Capital.

In its latest quarterly update, the LIC, which increased its net tangible assets by 8.7 per cent over the March quarter and by 112 per cent over the past year, said it was still bullish on equities even after the strong run since the market bottomed a year ago.

“Equities continue to look far more attractive than other asset classes, with cash and most investment grade bonds currently yielding less than inflation,” the fund manager said.

“We expect tailwinds for equities from monetary and fiscal stimulus, strong corporate earnings, rising M & A activity and the vaccine rollout (which will unleash enormous pent-up demand for a range of services).”

While investors are still favouring defensives such as technology, healthcare and supermarkets, the economic recovery and the path to a “COVID normal” environment will enhance the shift toward the hard-hit cyclical “COVID losers” in the coming months, L1 predicted.

The fund also sees the rotation to value gaining momentum. The recovery in value and cyclical stocks that kicked off in November failed to fire, with growth making a strong comeback. But L1 sees a shift as the global economy opens up from extended lockdowns.

“Value stocks have endured the largest and longest period of underperformance on record as bond yields have collapsed to historic lows, supporting the outperformance of long duration equities.

“COVID-19 exacerbated this trend, with a further melt-up in high P/E stocks as investors sought safety in ‘COVID winners’,” L1 said.

Growth stocks are currently trading at the widest premium to value stocks since the dotcom bubble of the late 1990s.

“This supports our view that there is still further to go to see conditions revert to a more balanced ‘equilibrium’.

“We believe the catalyst will be the combination of accelerating operating metrics for many cyclical stocks, along with a rise in long-term bond yields, particularly in the US and Australia,” the fund manager said.

While it is bullish on equities, the fund is bracing for rising inflationary pressures to hit as companies face a surge in input prices.

“From the dozens of company meetings we have held in recent months across many sectors, we have observed countless anecdotes of rising input costs for companies – retailers are grappling with freight costs that have surged 100-500 per cent, copper prices are up around 50 per cent, steel prices have nearly doubled, US lumber costs are up around 200 per cent,” it noted.

Price increases have been driven by a stronger-than-expected rebound in consumer demand as well as supply constraints caused by COVID-19 disruptions, L1 said, as it warned of inflation overshooting central bank expectations.

“While most of the factors driving inflation appear transitory, we are monitoring wage rates, energy markets and capacity utilisation to determine how persistent any rise will be.

“We are positioned to mitigate some of the risks from an increase in inflation with our bias towards short duration (value and cyclical) stocks, long positions in energy, gold and financials and short positions in some ultra-high P/E growth stocks (that should de-rate if inflation/bond yields increase).”