Welcoming a positive outlook in today’s financial market

The beginning of 2021 has been this hopeful space, with everyone working towards overcoming the pandemic. Vaccines are in production, air travel bubbles are in the works, vaccination drives are being rolled out, restrictions are evolving to allow the economies to re-open, and leisure travel seems to be just on the horizon.

Economists are projecting that global economies could reach herd immunity over the course of the next one to two years. We’ve seen markets taking this as a positive sign with the major US indices edging higher. Even the commodities market is starting to show signs of strengthening in risk-on sentiment with gold prices falling, coupled with a strong rally in oil prices.

We could, however, still have turbulence ahead. The US 10-year yields have pushed higher to about 1.56%. The cause for concern would be inflation rates hitting or exceeding the 2% mark, forcing central banks to raise interest rates ahead of expectations, thereby hurting risk-on assets globally.

This graph shows 10-year yields and 2-year yield spreads are still steepening. This is an indication that investors are generally still optimistic for the year ahead with risk-on assets remaining as the key play.

However, the Fed stepping in to control the rise could very well lead to a flattening of the yield curve and that would cause the risk-on sentiment to swing towards a more risk-averse stance.

So, how then can we better hedge our portfolio as we move into Q2? For starters, we can consider playing some defense by looking at the Utilities and Healthcare sectors.

The Defence Play

Utilities is a sector that we favor because it is non-cyclical and tends to hold itself well in a market downturn. In general, the utilities sector consist of companies that provide electricity, natural gas, water, and wastewater services to consumers, making them relatively stable as the services provided are necessities. Utilities stocks are also useful in helping investors to stabilize their portfolio by lowering volatility and risk exposure.

One stock that has benefitted from the current theme of green energy under the Biden administration would be NextEra Energy (NEE). This company is the largest US utility by market capitalization, and while a majority of the company’s revenue is generated from fossilfuels based sources, their heavy investments in renewables; so massive such that the renewable capacity could eclipse its fossil-fuel capacity by 2024, makes this company an ideal candidate for investors who want to capitalise on the shift towards renewable energy.

On top of that, NEE is also operating NextEra Energy Resources (NEER) which is the US’s largest supplier of alternative energy. With the high barrier of entry such as infrastructure, we expect to see lower competition from new entrants. Finally, the initiatives by the Biden administration to reduce carbon emissions in support of wind and solar energy, which comprises 20% and 25% of NEE originating power for utilities respectively, could see NEE continue to benefit.

Healthcare is another favourable defensive sector. It tends to have highly inelastic prices and are often supported by Government aid. With the ongoing race for COVID-19 vaccines, along with growing demand for healthcare goods and services, investors can consider adding Healthcare stocks into their portfolio for a steady momentum of upward trend.

A company worth considering is Johnson & Johnson (JNJ). A diversified healthcare giant that has its own pharmaceuticals division that focuses on manufacturing medicines for infectious diseases, neurological, and cardiovascular just to name a few. After releasing their single shot COVID-19 vaccine, attention has been brought to JNJ with President Biden planning to secure 100 million doses of the vaccine. Market capitalization of JNJ has been growing consistently year on year since 2017 with the estimated revenue growth for 2021 to be 11.4%.

Diversify With Aerospace

Now that we’ve considered the defensive sectors which would provide a good hedge to our portfolio against a market downturn, we should also consider balancing it with aggressive sectors as well, so that we can still ride out the bullish momentum in the market.

For this, we turn to the aerospace industry. Aviation is one of the fastest growing industries that has increased yearly at the rate of at least 14% until it was hit by the effects of COVID-19. Deloitte’s 2021 Aerospace and Defense Industry Outlook suggests that travel demand is not expected to return to pre-pandemic levels until at least 2024. However, we expect to see hope for this sector’s recovery in the near future for the following reasons.

Firstly, the aerospace industry is not just limited to commercial airlines and flights. It is divided into various sub sectors, some of which have shown potential to outshine commercial aerospace. One of such is the space sub-sector. Companies like SpaceX, Boeing, and Virgin Galactic are at the forefront of space exploration and are yielding results. Morgan Stanley estimates that the global space sector could generate revenue of US$1.1trillion by 2040. This presents a huge opportunity for the up-and-coming industry to bring its research and development to the next level as countries join the space race. The US recently established a sixth branch in its military in 2019 known as the “Space Force”. China and Russia are also developing interest in this sector, signaling possibly higher inflows of public-sector investment in the coming years.

Secondly, the defense sub-sector of aerospace is one that may have had its importance overlooked. Boeing, Lockheed Martin, and Raytheon Technologies are the main aerospace and defense manufacturers worldwide in 2020. Many countries have not significantly reduced defense budgets and remain committed to sustaining their military capabilities. Global defense spending is expected to grow again in 2021 by 2.8%, crossing the $2 trillion mark, as major defense spending economies are looking to keep up the pace to strengthen their military presence. The US foreign military sales topped $83.5 billion to offset flat domestic defense spending, while China announced a $178.2 billion military budget in May 2020. The continued flows of government spending into the defense sector in the aerospace industry is expected to keep the sector growing at a stable pace.

However, the commercial and general aviation aircraft manufacturing is still the largest sub-sector of the aerospace industry, so it is essential that we talk about how this sub-sector could recover from the aftershock of the pandemic. Starting this year, thanks to vaccine distribution and pent-up demand for air travel, the industry is poised to begin it’s recovery by the second half of the year. In China last September, there were a total of 371,000 domestic passenger flights, up 3.5% from a year ago. Domestic passenger numbers reached 47.75 million, 98% of 2019 levels. The International Air Transport Association (IATA) chief, Alexandre de Juniac, also announced that personal and leisure travel will likely return in the second half of 2021. Evidently, there is light at the end of the tunnel for the resumption of commercial air travel.

With the combination of optimistic investors, accommodative monetary policy, and government stimulus pushing the equities market to extend its rally, one question we keep getting is, “Is the rally sustainable and when would we be seeing a market reversal?” Truth be told, no one knows and while we cannot predict the market reversal, we can, however, manage our portfolio by introducing more defensive sectors to limit our volatility and risk exposure while capitalizing on aggressive sectors.

Andrew Leong is the COO at Everest Fortune Group, an awardwinning research house and official Singapore FinTech company that provides tailored solutions for brokers, traders, and portfolio managers.